Analyzing Transactions--Doing the Deal

Presenters: W. James LloydDouglas K. Anning

AHLA FRAUD AND COMPLIANCE FORUMOCTOBER 5-7, 2016

Doing the Deal

Prepared for AHLA Fraud and Compliance Forum

Douglas K. AnningDouglas Anning brings a unique blend of corporate mergers and acquisitions, corporate governance, healthcare and tax experience to serve health care and nonprofit clients. He is vice chair of Polsinelli's Nonprofit Organizations practice group and a member of the firm’s Health Care practice group, with a primary focus on nonprofit hospital mergers and acquisitions, nonprofit tax law, and nonprofit corporate governance.

Doug represents nonprofit and government hospitals, health systems, universities, academic medical centers, Catholic health systems, senior living, student housing, and other related health care and nonprofit organizations in a myriad of transactional work.

He serves nonprofit clients including private foundations, corporate foundations, schools and universities, healthcare conversion foundations, supporting organizations, endowments, and charitable lead and remainder trusts. A sought-after subject matter expert, Doug writes and lectures frequently on health care and nonprofit law and corporate governance, has co-authored several books, and is frequently quoted in Modern Healthcare and Bloomberg BNA Health Law Reporter. He is regularly recognized as a top attorney in his fields of health care and nonprofit law in both the Missouri & Kansas Super Lawyers and The Best Lawyers in America.


W. James LloydW. James (Jim) Lloyd is a Shareholder with PYA (Pershing Yoakley & Associates), a management consulting and accounting firm specializing in the healthcare industry. Jim’s primary areas of expertise include valuation (entities, joint ventures, complex business arrangements, and physician services agreements), transaction advisory, hospital-physician alignment, affiliations and alliances, and litigation/expert testimony services.

He has substantial healthcare industry experience including hospitals and health systems, ambulatory surgery centers, cancer centers, diagnostic imaging centers, dialysis centers, long-term care facilities, and physician practices. Other relevant industry experience includes managed care organizations, pharmacies, and pharmaceutical manufacturers among others.

Jim received his Bachelor of Science in Business Administration from the University of Tennessee and is a certified public accountant (CPA). He also holds several specialized credentials including: Accredited in Business Valuation (ABV), from the American Institute of Certified Public Accountants; Accredited Senior Appraiser (ASA), from the American Society of Appraisers; and Certified Fraud Examiner (CFE), from the Association of Certified Fraud Examiners.

He has published multiple articles on valuation-related topics and is a frequent speaker at conferences and other venues across the U.S.


Doing the Deal Key “pre-closing” considerations:

Strategic fit Valuation Due diligence Deal structure Documents


Healthcare Transactions Hospitals, physicians, and other organizations attempting

to compete (or survive!) in the current healthcare industry environment are aligning with one another via mergers and acquisitions, joint ventures, and affiliation arrangements at a torrid pace!

Common examples include: Large health systems acquiring smaller community hospitals Hospitals acquiring physician practices Physician practices merging Joint ventures between hospitals, physicians, and third-party

management companies Non-equity affiliations (e.g. “brand” and/or service agreements)


Healthcare Transactions These “alignment” transactions typically involve

substantial risks for each party, such as: Regulatory compliance risk Financial risk Operational risk Reputation risk

Clients often need substantial assistance from their outside legal counsel and consultants to successfully manage risk and keep the transaction moving forward in a timely manner.


Case Study #1Academic Medical Center (AMC) is interested in a potential cancer center joint venture (JV) with a local community hospital as part of its outreach program. Key issues include: Community hospital has an existing cancer program that

will be contributed to the JV. AMC’s “brand” will be utilized in connection with the JV. JV will have access to AMC’s physicians and “know-how.” Some patients that would have been treated at the AMC

will probably be treated at the JV facility instead.


Case Study #2Hospital in highly competitive market is interested in acquiring a large multi-location/multi-specialty physician practice that has historically been a significant referral source. Key issues include: Practice has 10 physician owners, 6 employed physicians, and 12

mid-level providers. Owners’ historical compensation is high relative to wRVUs; whereas

the employed physicians’ compensation is low relative to wRVUs. Substantial ancillary services. Two other hospitals have expressed interest in acquiring the

Practice. Physicians want substantial “up-front” cash and no reduction in post-

transaction compensation. Practice is interested in PSA deal structure due to governance

concerns.


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STARK LAW

Prohibited self-referrals for Medicare and Medicaid patients.

ANTI-KICKBACK STATUTEKnowingly and willful offers, payments, or receipts for referrals. Particularly important if a hospital is involved in the transaction.

IRS-NFP REQUIREMENTS

IRC Section 501(c) 3 requirements. Particularly important when valuing joint venture transactions involving a not-for-profit clinic or venture partner.

Navigating Regulatory Compliance


Fair Market Value Stark Law: Fair market value means the value in arm's-length transactions, consistent with the general

market value.1 "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, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement.2

Internal Revenue Service Revenue Ruling 59-60: The price at which the property would change hands between a willing buyer and a willing

seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.

1 Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.2 Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.


Fair Market Value – Key Concepts Value is determined from the perspective of unrelated

hypothetical buyers and sellers. Assumes arm’s-length negotiations with both parties

having reasonable knowledge of all relevant facts. Assumes neither party is under compulsion to buy or sell. Does not take into account any impact related to potential

future referrals or buyer synergies.


FMV - Case Study #1 Need to determine the fair market value of:

Community Hospital’s existing oncology service line that will be contributed to the new JV.

AMC’s “brand” (and any other intellectual property) that will be utilized by the JV.

Capital contribution credit or royalty payment. PSA for clinical services to be provided by AMC’s physicians. MSA for administrative services to be provided by AMC’s

oncology department leadership.


FMV - Case Study #2 Need to determine the fair market value of:

The physician practice being acquired Tangible and intangible assets Ancillary services may need to be broken out separately

Post-transaction physician compensation for the Practice’s current owners and employed physicians Note: the post-transaction FMV compensation should be taken

into account for purposes of determining the FMV of the Practice

PSA arrangement Compensation per wRVU plus any additional costs retained by

the physicians (e.g., malpractice, benefits, overhead, etc.) Quality incentives and/or other “administrative” type services

anticipated to be provided post-transaction


Commercial Reasonableness Department of Health and Human Services Definition1

An arrangement which appears to be a “sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.”

Stark Definition2

“An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services (DHS) referrals.”

OIG Threshold3

Compensation arrangements with physicians should be “reasonable and necessary.”

1 63 Fed. Reg. 1700 (Jan. 9, 1998).2 69 Fed. Reg. 16093 (March 26, 2004).3 “OIG Compliance Program for Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).


Commercial Reasonableness – Key Concepts

Commercial reasonableness is different than fair market value

Does the transaction make cents sense?

Focused on the business purpose of the transaction or arrangement.Is there a legitimate business reason to enter into this transaction/agreement?Did we contract with the most appropriate provider without duplicating facility need?Do the underlying economics of the transaction make sense?

Fair Market Value (NARROW) Commercial Reasonableness (BROAD)

Focused on the range of dollars being paid for the business, asset, or arrangement.


Evaluating Commercial Reasonableness

Please see PYA’s Commercial Reasonableness Handout.

CRAnalysis

Business Purpose Analysis

Provider Analysis

Facility Analysis

Resource Analysis

Independence & Oversight Analysis


FMV and CR – Additional Considerations Joint retention of one valuation firm by both parties vs.

each party hiring its own expert(s)? Engagement of valuation firm through outside counsel or

general counsel’s office for confidentiality purposes? Protocols related to communications, data sharing, etc. Coordination between the attorneys, valuation firm, buyer,

and seller is critical to keep the deal on track. Evaluation of preliminary FMV analysis before finalized to

ensure it aligns properly with deal structure and documents.

CR analysis and opinion(s) – process should be initiated early to avoid costly last-minute issues.


The Negotiation Quandary

How do you negotiate and draft an agreement and close the deal when fraud and compliance issues are suspected

or known?


Due Diligence Physician contract review: employment agreements, call

coverage, medical director, professional service agreements, MOB leases, etc.

Coding and billing Medical necessity Internal versus external consultant Attorney-client privilege Common interest/Joint defense agreements


Self-Disclosure Seller versus buyer disclosure Pre- versus post-closing Condition to closing Control of disclosure process post-closing Special indemnities

Versus claim for breach of representations and warranties Negotiating longer survival periods Not subject to baskets, caps, or other limitations Consider using pro-sandbag clause


Transaction Structure Asset purchase versus stock purchase (equity purchase

or member substitution) Included versus excluded assets

Assignment of physician contracts Assignment of provider number Assignment of licenses

Included versus excluded liabilities


Purchase Price Earnout provisions usually won’t work in these

transactions Alternatives

Closing conditions for work force/physician force in place (note: purchase price adjustment for physician retention post-closing poses greater risk)

Physician contracts Appropriate productivity-based compensation Liquidated damages Non-competes and other restrictive covenants


Representations and Warranties Representations and Warranties

Time period Materiality qualifiers Knowledge qualifiers

Key Healthcare R&W Healthcare laws Compliance programs Billing and coding Government and other payor programs Privacy and security Insurance Permits and licenses Material contracts


Disclosure Schedules Seller’s ability to update schedules Consequences of updating

Do supplements amend R&W for the closing condition Do supplements allow Buyer to terminate Do supplements cure breaches Can supplements update affirmative and negative disclosures Can supplements update new and retroactive information Should materiality (or MAE) be the threshold for any of the above Should Buyer have the right to consent to updates


Closing Conditions Bring Down of R&W No MAE Consents Licenses and Permits Approvals Updates Schedules Tail Insurance Satisfactory Completion of Due Diligence


Indemnification Breach of Representations and Warranties

Survival periods for representations and warranties Baskets, caps, and other limitations Definition and scope of damages (consequential, incidental,

special, punitive, diminution in value) Materiality and knowledge scrapes

Single versus Double Buyer versus Seller Perspective Compromises

Sandbag clauses Contract theory of recovery Tort theory of recovery (reliance) State default if silent


Indemnification Other Indemnities

Pre-Closing Conduct Excluded Liabilities

Special Indemnities Versus claim for breach of representations and warranties Longer survival periods No subject to baskets, caps, or other limitations Areas: Compliance, ERISA, Taxes, Known Litigation,

Employment Matters Who controls litigation/government investigation

disclosures Who controls settlement


Securing the Indemnity Obligation Holdbacks Promissory note with right of set off

Requirements under Stark for Isolated Transaction and Installment Note

Escrow


Exclusive Remedy Clauses Seller Friendly. Indemnification is Buyer’s exclusive

remedy. Buyer Friendly. Buyer has all remedies at law and equity

in addition to indemnification (e.g., rescission, restitution, specific performance).

Compromise. Indemnity is exclusive remedy except for fraud, criminal activity, willful misconduct, and/or equitable remedies.

Sample Language


Definitions--Damages “Damages” means all liabilities, damages, losses, fines,

penalties, deficiencies, assessments, obligations, recoupments of overpayments, demands for refunds or adjustments, charges, Taxes, actions, suits, proceedings, claims, demands, incidental damages, consequential damages, special damages, exemplary damages, punitive damages, judgments and settlements, costs and expenses (including interest, penalties and reasonable consulting and attorneys’ fees), diminutions in value, business interruption, lost profits, other damages of any kind, nature or description, costs of Cleanup or containment or other remediation, and all reasonable amounts paid in investigation, defense, or settlement of any of the foregoing. Further, “Damages” may be calculated on a multiple of earnings, discounted cash flow, or other methodology that may have been used in determining the Purchase Price or relate to the value determined by Purchasers for the Purchased Assets.


Definitions--Knowledge “Knowledge” An individual will be deemed to have “Knowledge” of

a particular fact or other matter if (A) such individual is actually aware of such fact or other matter, or (B) a prudent individual could be expected to discover or otherwise become aware of such fact or other matter in the course of conducting (or having been deemed to have conducted) a reasonable investigation concerning the existence of such fact or other matter including, without limitation, inquiry with direct reports and others likely to have actual knowledge of the fact or matter. A corporation, association, partnership, limited liability company or other entity (“Entity”) will be deemed to have “Knowledge” of a particular fact or other matter if any individual who is serving, or who has at any time served, as a director, officer, stockholder or shareholder, member, manager, partner, employee, agent, contractor, representative, executor, or trustee of such Entity (or in any similar capacity) has, or at any time had, Knowledge of such fact or other matter.


Definitions—Material Adverse Effect “Material Adverse Effect” shall mean any result, occurrence, fact, change,

event or effect that results in, or could reasonably result in, a materially adverse effect on the business, assets, liabilities, employees, capitalization, condition (financial or other), results of operations or prospects of Seller (taken as a whole) including, without limitation, actual or potential Damages to the Health System Businesses, taken as a whole, in an aggregate amount equal to or exceeding $[____], or the ability of a Party to consummate the Contemplated Transactions, except to the extent resulting from (i) changes in general local, domestic, foreign, or international economic conditions, (ii) changes affecting generally the health care industry or markets in which Sellers operate, (iii) losses from operations of the Health System Businesses that are materially consistent with the historical and projected run rate of the Health System Businesses [seller friendly—buyer would likely reject], (iv) acts of war, sabotage or terrorism, military actions or the escalation thereof, (v) any changes in applicable Legal Requirements or accounting rules or principles, including changes in GAAP, (vi) any action required by this Agreement, or (vii) the announcement of the transactions contemplated by this Agreement.


Conditions to Closing—Bring Down Provision

Seller Friendly: Each of the representations and warranties of Seller shall be true and correct at and as of the Closing except for such failures to be true and correct that would, taken together, result in a Material Adverse Effect. [Buyer could consider adding a materiality scrape like is in the next clause.]

Buyer Friendly: Each of the representations and warranties of the Seller shall be true and correct at and as of the Closing, in each case disregarding limitations or qualifications as to dollar amount and the terms “material,” “materiality,” “material adverse effect,” and “knowledge.” [Seller would likely object to the materiality scrape as it negates all the materiality qualifiers in the R&W.]

Compromise: Each of the representations and warranties of Seller that is qualified as to as materiality (including “material” and “material adverse effect”) shall be true and correct at and as of the Closing, and each other representation and warranty shall be true in all material respects at and as of the Closing.


Closing Conditions—MAE and Updated Schedules Buyer Friendly. The Updated Schedules are satisfactory

to Purchasers in Purchasers’ sole and absolute discretion.

Compromise. From and after the date of this Agreement there shall not have occurred any result, occurrence, fact, change, event, or effect that has resulted in, or could reasonably result in, a Material Adverse Effect, including, without limitation, any result, occurrence, fact, change, event or effect included in any supplement or amendment to the Schedules hereto from and after the Effective Date.


Indemnification—Materiality and Knowledge Scrapes

For purposes of determining whether any inaccuracy or breach of any representation or warranty occurs and the amount of Damages for any breach of any representation or warranty of a party hereto, any inaccuracy in or breach of any representation or warranty shall be determined without regard to any materiality, material adverse effect, knowledge or other similar qualification contained in or otherwise applicable to such representation or warranty.


Indemnification--Sandbagging The right to indemnification, payment of Damages or other remedy based

on such representations, warranties, covenants, and obligations will not be affected by any investigation conducted with respect to, or any Knowledge acquired (or capable of being acquired) at any time, whether before or after the execution and delivery of this Agreement or the Closing Date, with respect to the accuracy or inaccuracy of or compliance with, any such representation, warranty, covenant, or obligation. The waiver of any condition based on the accuracy of any representation or warranty, or on the performance of or compliance with any covenant or obligation, will not affect the right to indemnification, payment of Damages, or other remedy based on such representations, warranties, covenants, and obligations. Sellers hereby acknowledge that, regardless of any investigation made (or not made) by or on behalf of Purchasers, and regardless of the results of any such investigation, Purchasers have entered into the Contemplated Transactions in express reliance upon the representations and warranties of the Sellers made in this Agreement.


Indemnification—Anti-Sandbagging The Purchaser acknowledges that it has had the

opportunity to conduct due diligence and investigation with respect to the Company, and in no event shall the Seller have any liability to the Purchaser with respect to a breach of representation, warranty or covenant under this Agreement to the extent that the Purchaser knew of such breach as of the Closing Date.


Indemnification—Set-Off Rights Purchasers will have the right to set off any amounts due

under this Article [] [the indemnification article] against any amounts then or thereafter owing from Purchasers to Sellers under this Agreement or any of the Transaction Documents or otherwise, including, but not limited to, any amounts due to Sellers under any one or more of the Promissory Notes, in Purchasers’ sole and absolute discretion.


Polsinelli provides this material for informational purposes only. The material provided herein is general and is not intended to be legal advice. Nothing herein should be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, rules and regulations, and other legal issues. Receipt of this material does not establish an attorney-client relationship.

Polsinelli is very proud of the results we obtain for our clients, but you should know that past results do not guarantee future results; that every case is different and must be judged on its own merits; and that the choice of a lawyer is an important decision and should not be based solely upon advertisements.

© 2016 Polsinelli PC. In California, Polsinelli LLP. Polsinelli is a registered mark of Polsinelli PC

PERSHING YOAKLEY & ASSOCIATES, P.C.800.270.9629 | www.pyapc.com

W. James LloydShareholder | [email protected]

(865) 684-2805

Douglas K. AnningShareholder | [email protected]

(816) 360-4188

mailto:[email protected]

mailto:[email protected]

Analyzing Transactions--Doing the Deal

Healthcare

Transcript of Analyzing Transactions--Doing the Deal