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Acquisitions of Community Hospitals by Not for Profit and
Profit SystemsAHLA PHYSICIANS AND HOSPITALS LAW INSTITUTE
FEBRUARY 8-10, 2016
DAVID LEWIS CHRIS
CARNAHAN MILLER & MARTIN CARNAHAN GROUP
Presentation Outline
• Key Differences Between Fair Market Value and Fairness Opinions• Drivers Behind Acquisitions of Community Hospitals • Legal Considerations Related to Community Hospital Acquisitions and
Discussion of Structural Options • Due Diligence Considerations from Buyer and Seller Perspectives • Discussion of Community Issues• Completing the Deal Structure from Letter of Intent to Full Integration• Tax Issues that May Impact the Deal• Obtaining Necessary Regulatory Approval Including State Attorney
General Approval
Fair Market Valuation vs. Fairness Opinions
• Fair Market Valuations are similar to Fairness Opinions, but are different and used for different purposes
• Seller: hypothetical seller
• Buyer: hypothetical buyer• Terms: cash or NPV of cash• Purpose: value subject
entity or asset• Preparer: independent
expert• Prepared for buyer and/or
seller
• Actual Seller• Specific Known Buyer or buyers• Terms and conditions may vary• The purpose is to provide stake
holders with an opinion• Independent expert• Prepared for those who have
fiduciary duty
Fair Market Valuation
• Fair market value is generally defined as:• “The price, expressed in terms of cash equivalents, at
which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Fair Market ValuationModified by Stark
• “…“General market value” means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party…”
• “…acquisition, or the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals… (42 CFR §411.351)”
Valuation Overview
• Three traditional approaches can be used to value an interest in a closely held entity: • Asset (cost) approach• The asset approach considers the cost to reproduce or replace the
property appraised• Reproduction Cost – Contemplates total cost construction of the exact
replica of the subject assets using current prices.• Replacement Cost – Contemplates the cost to recreate the functionality
or utility of the subject assets• Market approach • Values are estimated by adjusting the prices that have been paid for
assets comparable to the asset being appraised• Income approach• Establishes value by methods that capitalize future anticipated
benefits
Fairness Opinions
• The opinion is usually issued to the fiduciaries of an organization or those with governance responsibilities owed to the stakeholders.• Although a fairness opinion relies on similar
methodologies for reaching a conclusion or an opinion, it does not necessarily reach a value estimate. • It rather expresses an opinion of the fairness of the
terms and conditions it offers to the stakeholders.
Fairness Opinions, Cont’d
• A fairness opinion takes into account important transaction terms and circumstances including the acquirer’s ability to successfully close the transaction and operate the organization.• Since the goal of a fairness opinion is to express to the
stakeholders of an organization whether the proposed transaction is fair from a financial point of view it is important to consider the stakeholders’ will and in the case of charitable organizations to consider the mission of that organization.• “In a 1999 New York Supreme Court decision, In re
Manhattan Eye, Ear and Throat Hospital criticizes a nonprofit board’s process for deciding to abandon the traditional nonprofit hospital mission of the corporation.”
What Are Community Hospitals facing?
Capital Constraints
Growing IT Infrastructure Requirements
HealthcareReform/Regulatory Uncertainty
Decline in Admissions
Integration of Healthcare Providers
Shortage of Physicians and Healthcare Professionals
Major Pressures on the Health System
• Credit Rating Requirements
• Employed Physician Losses
• Uncertainty about reimbursement• Sequestration
• Health Insurance Exchange
• No Medicaid Expansion
• Operating Costs• Capital Requirements
• RAC Audits• ICD-10
• Price Transparency• Payer Mix Change
Hospital Acquisition and Consolidation Models
• Clinical Affiliations• Facility Management Agreements • Joint Operating Companies• Long Term Leases • Nonprofit Mergers and Member Substitutions• Asset Purchase Agreements • Stock Purchase Agreements
Changing Landscape• Traditional for-profit transactions involved an acquisition of
assets with little or no remaining form of local control or influence.
• Many of the more recent transactions demonstrate a willingness on both sides to share equity and control-Governance Structures can be complex.
• Other complicating factors: non-profit mission, Catholic identity, public entity obligations.
Degree of IntegrationLow High
Degree of Non-Profit ControlHigh Low
Affiliation
Management Services Agreement
Sale of Minority Interest
Joint Operating Agreement
Sale of Controlling
Interest
Change of Corporate Member
Sale/Acquisition
Merger
Emerging Structures Joint
Venture
TraditionalFor-Profit
Transaction Structure
Joint Venture
Examples of Minority Interest Joint Ventures
Minority Interest Joint Ventures
Source: Kaufman Hall
Collaborative Purchasing and “Best Practice”
Management Services
Agreement
Joint Operating Agreement
Alternative Models of Collaboration
Joint Operating Company
• A “JOC” is a legal structure that allows the joint operation of services and business activities among hospitals that are not jointly owned. • A Joint Operating Agreement or “JOA” allows
participating hospitals to retain separate boards of directors, but turn over management functions to a separate entity.
Joint Operating Company, Cont’d
• A JOC is formed according to the terms of a JOA, which is the formal legal agreement defining the terms of combined operations• Sometimes referred to as a virtual merger • May be used to integrate operations without
actually transferring assets
Long-Term Facility/Operations Leases
• Long-term lease (e.g., 20+ years) • Lessee takes control and is responsible for all
operations, revenues, and expenses (e.g., capital expenditures, physical plan maintenance) • Lessee makes lease payments to lessor • Majority of these models are between a
municipality/government entity and a for profit or nonprofit system • At the end of the lease term, hospital control
reverts to lessor
Nonprofit Mergers & Membership Substitutions
• Brings together two or more hospitals/health systems, combining assets and liabilities (may be separated by facility or region)• Generally cashless transactions (future capital
commitments/other funding requirements/assumption of liabilities common)• Goal of strong integration; shared contracting;
economies of scale
Asset PurchasesNonprofit Sale to a Nonprofit
• The purchaser assumes responsibility for assets and liabilities • May include some purchase price component but
typically more of a bail-out situation• Buyer assumes control over hospital and physical
assets • No conversion foundation (charitable foundation)
needed since any dollars remain with exempt entity
Asset Purchases, Cont’d
• Often requires capital commitments and continued level of service for period of time • Typically a city, county or other governmental
hospital (change of control not an option) • May include right of first refusal on any
subsequent sale after minimum period of operations by buyer • May require public referendum in addition to board
approvals
Asset Purchases, Cont’d Not for Profit Sale to a For Profit
• The purchaser buys the seller’s hospital and physical assets • The seller repays non-assumed debt/liabilities • Unless part of a system with remaining exempt
hospitals, seller uses existing foundation (converted) or establishes conversion foundation• Keeps any net proceeds for the benefit of the
community/to further the seller’s original mission
Asset Purchases, Cont’d
• Seller may negotiate some continued presence on the board • If then part of a larger system, such as a national
for profit company, the board may only be an advisory board with limited fiduciary duties and oversight over local medical staff and quality of care matters in accordance with Joint Commission and state law requirements
For Profit Stock or Asset DealsFor Profit to For Profit Transactions
• The purchaser buys the seller’s hospital and physical assets through stock or asset purchase• In an asset deal, the seller repays non-assumed
debt and liabilities • In a stock deal, buyer accepts assets and
liabilities, stepping into shoes of seller(s)
Legal Hurdles & Regulatory Approvals
• Financing – Covenant Restrictions • State Certificate of Need Laws • Attorney General Review • Catholic Issues • Antitrust Considerations• Health Care Compliance Issues
Financing
• Contractual obligations common in financing documents • Bond covenant restrictions can impede transaction
or require significant debt restructuring • Carefully assess financing/refinancing implications
early on, as this may drive the ultimate structure of a transaction
Certificates of Need
• Assess need for CON early on • Work timing into transaction• Gauge potential level of scrutiny and prepare in
advance • Anticipate and prepare for fairness, access, charity
care, scope of services, staff reductions and other concerns (which also impact Attorney General review)• Build internal and external constituency of support
Important Steps in an Acquisition
• Buyer assesses need• Board committee • Selection process (RFP, networking, etc.)
• Letter of Intent • Due Diligence • Definitive Agreement • Approvals and Notifications• State licensing/CON• Attorney General approval
Assessing the Need to be Acquired
• Financial Considerations• Strategic Considerations• Importance of Mission• Board fiduciary duties including duty of care and
duty of loyalty • Document decision process carefully • Engage consultants, financial advisors and legal
counsel at the outset
Address Financing and Valuation Issues
• Review all financing documents • Perform capital needs assessment (upgrade or
require replacement facility) • Establish fair market value
Letter of Intent
• Include the “big picture” issues such as capital projects, type of transaction, governance roles and consideration • Assumed and Excluded Assets and Liabilities • Employee matters and pension commitments • Charity Care • Use of Names • Physician Recruitment/Medical Staff • Exclusive Dealing • Due Diligence/Access to Information
Due Diligence
• Extensive review of financial and operational compliance • Licensure/CON • Physician Agreements (Stark Law and Anti-Kickback
issues)- may trigger need to self-disclose • Termination fees/assignability of contracts • Billing/Coding review • Pending/Threatened litigation• Cost Reports/RAC Audits • Accreditation Survey and licensure issues
Purchase Agreement
• Timing of Execution/Closing
• Price, including adjustments
• Contracts Assigned
• Pre-closing covenants
• Conditions to closing (think party approvals, WARN Act notices, licensing)
• Post closing covenants (non-competition covenants, retention of specific health care services)
• Seller’s representations and warranties • Financial Statements • Taxes • Recent material events • Licenses • Managed Care Contracts and Medicare/Medicaid participation
• Health Care Compliance
Approvals and Notifications
• Seek regulatory approval as the Purchase Agreement is reached • State regulatory approval – licensure, CON, other
state health regulatory approval• HSR Notification if required (Antitrust/FTC)• WARN Act (employee termination) notices • State Attorney General approval• Other Approvals
Tax Issues that Impact the Deal
• Maximizing shareholder value vs. public benefit and good• Different consequences from different types of
structuring• Will organizations tax-exempt status survive?• Private foundations • Purchase price allocation differences
Local and Community Issues
• Access to care• Access to similar level of services• Hospital employment • Economic multiplier effect• Charitable mission• Profitability of service lines• Cultural sensitivity and control
State Attorney General Approval
Most states have statutes that require approval of the Attorney General for the disposition of a nonprofit corporation to a for profit corporation and the statutes are often specific to hospitals because of their importance to the community
• Examples include the Georgia Hospital Acquisition Act, O.C.G.A. §31-7-400 et seq.) and the Tennessee Public Benefit Hospital Sales and Conveyance Act of 2006, Chapter 930 of the Public Acts of 2006
• Notice to Attorney General
• Public hearing is generally required
• Factors the Attorney General must consider, including access to care and cost of care , are set forth by statute or practice
Attorney General approval should never be assumed
• Tenet Healthcare withdrew its bid to buy 5 Connecticut Hospitals allegedly due to conditions placed on the transaction by State regulators.
• In California, Prime Healthcare backed out of a transaction with Daughters of Charity due to conditions placed on the transaction by Attorney General
• Find out early how Attorney General has viewed similar transactions
Preparing Testimony Before the Public and Attorney State General
• Furthermore in our fairness opinion we have considered Louisiana statute, §40:2115.18. “… the attorney general shall also determine whether the acquisition affects the continued existence of accessible, affordable health care facilities that are responsive to the needs of the community. In making this determination, the attorney general shall consider:• (1) Whether sufficient safeguards are included to assure the
affected community continued access to affordable care.• (2) Whether the purchaser and parties to the acquisition have
made a commitment, at least comparable to the seller, to provide health care to the disadvantaged, the uninsured, and the underinsured and to provide benefits to the affected community to promote improved health care… shall be considered in evaluating compliance with this commitment.”
Preparing Testimony Before the Public and Attorney State
General, Cont’d
• Although our opinion is limited to the reasonableness and fairness of the monetary consideration exchanged; these two entities are both Acadiana charitable healthcare organizations • We have taken into consideration the impact of this
transaction on the various stakeholders of the region: patients, employees, vendors, local businesses, and the community at large• Nor have we forgotten the cultural nuances of this
region and the importance of cultural sensitivity in the delivery of healthcare
Questions/Comments
Thank you for the privilege of presenting.
Chris Carnahan David LewisCarnahan Group Miller & Martin PLLCPresident Chair, Health Care Practice
Group5005 West Laurel Street, Suite 204 401 Commerce Street, Suite
720Tampa, FL 33607 Nashville, TN 37219(813) 289-2588 (615) 744-8605