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A Guide to Selling your Practice or Cardiovascular Imaging Lab to a Hospital: Frequently Asked Questions
March 26, 2010
Despite rigorous advocacy efforts by the American Society of Echocardiography and other organizations representing cardiologists, the 2010 Physician Fee Schedule implements extraordinarily steep Medicare payment reductions for cardiology services—and especially for cardiovascular imaging services, such as echocardiography and SPECT. The announcement of these reductions, most of which will be phased in over the next four years —has spurred many cardiology practices to consider selling their practices, or the echocardiography lab or nuclear lab component of their practices, to area hospitals.
Significantly, the Medicare Program reimburses hospitals significantly more than the Physician Fee Schedule for both cardiovascular imaging services and for office visits. Payments to hospitals for these services are determined under the Medicare hospital outpatient prospective payment system, which is based on hospital charges, so services that are not financially viable under the Medicare Physician Fee Schedule may be financially viable for hospitals. But while hospital outpatient echocardiography and nuclear cardiology services are reimbursed at significantly higher rates than the same services provided by a physician practice, certain very specific regulatory requirements must be met for this increased payment to be available to the hospital. These requirements are set forth in Medicare’s “provider-based status” regulations, which are complex and somewhat confusing in a number of important respects.
Hospital ownership of physician practices was in vogue in the 1990s, with decidedly mixed results, both for physicians and for hospitals. Many of the physician acquisitions that took place during this period unraveled, as physicians became disenchanted with hospital management and bureaucracy and hospitals became frustrated with declining productivity of employed physicians who were no longer as motivated to maintain their prior patient loads.
So why would a hospital be interested in purchasing your practice now? Many hospitals are beginning to experience the repercussions of a growing physician shortage. Increasingly, hospitals are having difficulty convincing physicians to take on-call coverage, and this problem is especially acute for specialty coverage. In addition, government policies are beginning to focus on increased coordination in the management of patients with chronic conditions in the outpatient environment, in an effort to reduce the costs of inpatient admissions, through the concept of the “medical home” and similar efforts. Under these models, controlling the care coordinator is critical; physicians are the key “care coordinators;” and cardiac conditions are among the most common chronic conditions that require outpatient management. Controlling the provision of cardiology services in an area also increases a hospital’s leverage to negotiate with non-governmental third party payers. Finally, but perhaps most importantly, a hospital has significant flexibility to control an employed physician’s referrals, while attempting to control the referrals of independent physicians will necessarily engulf a hospital in a legal quagmire of federal physician self-referral, anti-kickback and similar state prohibitions.
The legal, financial, and management issues involved in the sale of your practice (or any component of your practice) to an area hospital are daunting for most physicians. This article, which is formatted in the form of “Frequently Asked Questions”—is intended to provide preliminary guidance to those physicians who are considering entering into this process. If you decide to proceed down this path, however, it is crucial that you engage an experienced health care lawyer.
Should I sell my entire practice, or only that part of my practice that I can no longer support under Medicare’s new payment rates (e.g. my echo lab and my nuclear lab)?
The answer to this question depends in large part on your objectives. If you have become disheartened by the increasing challenges of running a private practice and are willing to forego control over the business aspects of practicing medicine in order to focus on clinical care, it may be wise to consider selling the entire practice. From the standpoint of eliminating practice management hassles, selling the entire practice and simply becoming an employee of the hospital or a related entity is by far the simplest and most straight-forward way to go.
However, if you and the members of your practice wish to continue to operate a private practice independent of the hospital, but wish to sell those components of the practice that have become financially unsustainable under Medicare’s new reduced rates for echocardiography and/or nuclear cardiology services, this is also legally feasible, provided certain conditions are met. If you pursue this model, it may be possible for your practice to continue to manage the echo or nuclear laboratory that you sell to the hospital, so long as the amount paid by the hospital for the management services is fair market value and certain other legal requirements are met.
Can’t we just joint venture our echo/nuclear lab with the hospital and split the increase in the Medicare reimbursement that will result from the lab’s being operated as a hospital-based service?
The answer to the question of whether a facility can be operated as a joint venture and still qualify for hospital-based status depends on the location of the facility, the extent to which you are willing to allow the hospital to exercise control over the organization and operation of the lab, and a number of other factors. More specifically, in order for services to be billed as hospital outpatient services, the services must be provided in compliance with Medicare’s “provider-based status” regulations, and these regulations preclude a joint venture that is not located on the hospital’s campus from qualifying for hospital-based status. In addition, a number of other requirements—many of which require relatively tight control of the facility by the hospital—must be met.
In addition, in areas that do not qualify as “rural”, the federal physician self-referral law (the “ Stark law”) precludes a physician from having a direct or indirect ownership interest in an echocardiography or nuclear cardiology laboratory to which the physician refers patients, unless the arrangement qualifies for the “in office ancillary services“ exception (the so-called “group practice exception”), While cardiology practices generally can be structured to fall within the requirements of this exception, these requirements likely could not be met if your practice provides echocardiography/nuclear services through a hospital-physician joint venture and all other cardiology services through your existing practice. Thus, there are considerable legal obstacles to simply “joint venturing” your echo or nuclear laboratory with an area hospital to obtain a share of the increased reimbursement available to hospital-based facilities.
Well, if I can’t joint venture my echo/nuclear lab, can I just sell it to the hospital outright?
Yes, but assuming that you refer Medicare patients to the hospital and will continue to do so after the lab is sold, it will be important for the transaction to meet the requirements of a Stark Law exception. There is a Stark Law exception for “isolated transactions” that was intended to enable physicians to sell their practices (or other assets) to a hospital (or other entity to which Medicare patients are referred). However, this exception imposes some unusual requirements. For example, it requires that you forego any other financial relationship with the hospital for a period after the acquisition, unless that relationship independently qualifies for an exception to the Stark Law. The isolated transaction exception also allows only certain types of installment sales.
In addition, please be aware that the sale of your echo/nuclear laboratory to an area hospital also may raise legal issues under the Medicare/Medicaid anti-kickback provisions of the federal fraud and abuse law (the “Anti-Kickback law”). The Anti-Kickback law imposes both criminal and civil penalties on those who pay or receive remuneration in exchange for, or to induce, referrals of patients covered under certain governmental programs, including Medicare and Medicaid. Transactions that meet the requirements set forth in certain “safe harbor” regulations are deemed to comply with the anti-kickback prohibitions; however, with the exception of certain practice acquisitions in Health Professional Shortage Areas and transactions involving the acquisition of one practice by another practice, there are no “safe harbor” regulations that specifically protect practice acquisitions. While most experienced health care lawyers attempt to structure transactions to resemble safe harbor transactions to the extent feasible, the legality of a practice acquisition under the Anti-Kickback law depends on the intent of the parties, which is generally inferred from the facts and circumstances involved in each particular transaction. Therefore, the sale of your practice—or any component of your practice—to an area hospital necessarily entails some degree of regulatory risk.
Does it make a difference whether we sell just our echo/nuclear lab or our entire practice?
Of course, it will make a financial difference, and a difference in terms of the extent to which you continue to control how services are provided to your patients. However, it also may make a legal difference as well. In general, regardless of whether you sell your entire practice or one component of it, the sale will have to meet certain Stark law and Anti-Kickback requirements, including, most importantly, a requirement that the purchase price be “fair market value.” If you sell your practice entirely and become an employee of the hospital (or of some other entity in a hospital “system”), there will be additional Stark Law/Anti-kickback law considerations: The employment arrangement will have to fit within an employment exception to the Stark Law and anti-kickback prohibition.
Likewise, if you sell some component of your practice but continue to manage that component under a contract with the hospital—or have any other ongoing financial relationship with the hospital—that relationship will be required to meet the requirements of a Stark Law exception and will have to pass muster under the Anti-Kickback law. In this regard, some practices retain ownership of some of the practice’s “hard assets” (e.g. the building or equipment or both), and lease those assets to the hospital. If this structure is used, these leases must meet both Stark law and anti-kickback requirements. Such a structure may be especially useful when it comes to fashioning workable “unwinding” provisions to take effect in the event that the arrangement does not meet the parties’ expectations.
If we do decide to sell either part or all of our practice to the hospital, what are the steps that will be involved?
There are five aspects of physician practice acquisitions:
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The valuation of the practice (or service);
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Structuring the practice acquisition;
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Due diligence and negotiation of the purchase agreement;
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Physician employment agreements (if applicable);
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Non-competition agreements.
How will the value of my practice (service) be determined?
The appraisal process involved valuation of at least five components of the practice (service): hard assets, accounts receivable, cash, real estate, and goodwill. There are three basic approaches to valuation: the income, market, and cost approaches.
The income approach generally focuses on the value of a business’s future income stream. For example, the discounted cash flow approach, which is the most commonly used type of income approach, estimates the present value of the future cash flows based on historical performance, industry benchmarks, and expected future performance. In addition, some valuations use another income-based approach, using a multiple of EBITDA (Earnings before interest, taxes, depreciation and amortization.
By contrast, the market approach measures the value of a business by comparing it to the purchase price of recent sales of comparable businesses. Unfortunately, in the case of the sale of a physician practice, comparables may be difficult to locate.
The cost approach estimates the value of a business by measuring the cost to reconstruct or replace the business with another business of comparable value. When evaluators are engaged to value physician practices, they must weigh these three approaches and determine which method or combination of methods is appropriate.
My hospital says that it can’t pay us what we believe our practice/ service is worth because of regulatory concerns. Could that be true?
Yes, maybe. The Office of the Inspector General has issued a number of public statements suggesting that the amount paid by a hospital for a physician practice and the amount and manner in which a physician is subsequently compensated for providing services to patients may implicate the fraud and abuse laws. Specifically, there has been significant controversy over whether, and to what extent, a hospital can pay for “goodwill”. While payments for goodwill are not illegal per se, the amount paid by a hospital for a physician’s practice that is over the fair market value of the hard assets is subject to question. For this reason, it is prudent to substantiate the fair market value of the practice through a valuation by a third party.
What are the options for structuring the transaction?
Acquisitions of physician practices are generally structured as asset acquisitions; however, in the case of practices organized as “C” corporations, a stock purchase or merger may be more appropriate, due to tax considerations. Often, a hospital will utilize a subsidiary organization to purchase the practice or facility, to help insulate the hospital from potential liability. Please note, however, that to the extent that a hospital wishes to obtain payment for the practice’s echo/nuclear or other technical component services under the hospital outpatient prospective payment system, it may be necessary for these services to be operated by the hospital itself, rather than a hospital subsidiary or other non-hospital legal entity, due to the provider-based status regulations. The same requirement applies if the hospital wishes to obtain a facility fee for the services that physician practices consider office visits—and that the hospital may wish to characterize as “clinic” visits.
What is due diligence and what types of documents will the hospital want to examine during this process?
The due diligence process is intended to provide the prospective purchaser (the hospital) with the opportunity to identify and evaluate information necessary to understand the actual value of the practice, and for the parties to negotiate the representations and warranties provisions in the purchase agreement to allocate known (or know-able) risks. For example, if there is an ongoing or threatened lawsuit, the hospital may wish to ensure that the purchase agreement is drafted in a manner that clearly allocates the financial risk.
The hospital, and/or the appraisal company, may seek access to a broad range of documents, including documents that you would otherwise consider extremely confidential. Before the hospital initiates due diligence, you should have in place a non-disclosure agreement with the hospital, to ensure that the information that becomes known to the hospital during the due diligence process regarding your practice’s finances, patient base, marketing strategies, and other sensitive information is not publicly released.
After the practice acquisition, can I be employed directly by the hospital?
The answer to this may depend on state law. Some states have passed laws precluding the “corporate practice of medicine” and in some, a similar preclusion has developed through case law. These prohibitions are intended to prevent business entities from interfering with the physician’s professional judgment in the practice of medicine. When direct employment of a physician is precluded by state law, some of the same objectives usually can be obtained by establishing a professional corporation, LLC, or other entity that is controlled indirectly by the hospital. However, in this case, it may not be possible for the hospital to obtain the increased Medicare payment for the services that is available under the hospital outpatient prospective payment system.
If I am employed by a hospital, does my compensation have to be limited to a straight salary (plus fringes), or is some kind of productivity bonus possible?
It is important that any productivity bonus formula be structured to meet an exception to the Stark Law and, if possible, a “safe harbor” under the Anti-Kickback statute. Additional constraints on productivity bonus formulas are applicable to hospitals that are exempt from taxation under Section 501( c)(3), since these institutions must avoid the appearance of private inurement, which may result in significant tax penalties for the hospital.
Increasingly, physician compensation agreements negotiated by hospitals include some kind of productivity bonus, which may be determined based either on your own individual productivity or the productivity of a department or group of physicians—so long as the volume or value of referrals are not taken into account. Many productivity bonuses are based on relative value units (RVUs), physician-generated “net revenue,” or net collections. Through ever more complex productivity bonus formula, hospitals are seeking to share financial risk with physicians, such as the financial risk of cost overruns and bad debts.
From a legal standpoint, it is critical that the compensation be at fair market value and that the compensation formula exclude consideration of the volume or value of referrals, and that certain other requirements are met. A number of external benchmarks are available to determine the fair market value of the services of various kinds of medical specialists.
If I am employed by a hospital, can the hospital require me to refer my patients to hospital-owned facilities?
It depends. The Stark Law regulations allow a hospital to require a physician to make referrals to a particular provider, practitioner, or supplier unless the patient expresses a preference for a different provider, the patient’s insurance determines the provider or the referral is not in the patient’s best interests in the physician’s professional judgment. In addition, the required referrals must relate solely to the physician’s services covered by the scope of the employment contract, and the referral requirement is reasonably necessary “to effectuate the legitimate business purposes of the compensation relationship.” 42 CFR Section 411.354(d)(4)(2008).
Aside from salary, what should I be thinking about when I negotiate an employment agreement with the hospital?
In addition to salary and other elements of compensation, such as fringe benefits, vacation time, etc., it is important to pay close attention to the other terms and conditions of employment. Don’t forget that your leverage will never again be as strong as it is when you are negotiating your initial employment agreement. Special attention should be paid to the term and termination clauses in your employment agreement, and to the scope and duration of the non-competition clause. In addition to negotiating the hours you will work and your on-call commitment, you may wish to designate the location where your services will be provided (e.g. at the main hospital building, in an outlying clinic, or in the location of your old practice). If you are not confident of the hospital’s ability to bill accurately for physicians’ services, now is the time to consider requesting the hospital to engage a billing service, or to negotiate the employment of your own billing personnel to bill for your services. Consider the hospital’s lines of authority, and make sure that it is clear who you will be reporting to. If you will be supervising the hospital’s echo/nuclear laboratory or providing any other administrative or clinical services to the hospital, make sure that these are specified in sufficient detail and that you have the requisite authority to recommend the hiring and firing of the clinical personnel for whom you will have responsibility. In other words, consider everything that has or can affect your work life—not just the financial deal—and make sure that any “deal breakers” are addressed either in your employment agreement or in the purchase agreement, or both.
Signing a non-competition agreement makes me nervous. Are non-competition agreements legal?
Non-competition agreements may be requested by the hospital as a condition of the practice acquisition or as a condition of employment. The legality of a non-competition agreement depends on state law. Non-competition agreements that are overly broad may not be enforceable in the courts; however, restrictions that are reasonable in time and geographic scope may be. Longer and broader non-competition agreements may be allowed by the courts if they are negotiated as a part of a hospital’s purchase of a physician’s practice than if no practice acquisition is involved. On the other hand, non-competition clauses that are included in employment agreements generally extend for some period after employment is terminated, while non-competition provisions in purchase documents generally extend from the closing date of the acquisition. Since the time periods involved may be different, make sure to understand completely the non-competition restrictions included in both documents.
In conclusion, the process of selling your practice—or any component of your practice—to a hospital is one of considerable complexity, from a legal standpoint. From a practical perspective, the process involves understanding and carefully considering the trade off between financial security on the one hand and autonomy on the other. And, no matter how attractive selling your practice may seem in the short term, in light of the history of such transactions in the past and the vagaries of the future, both physicians and hospitals are well advised to think through how the transaction can be unwound in the event that the parties’ expectations ultimately are not met.
