Acquisitions of Community Hospitals by Not for Profit and Profit
Systems
AHLA Physicians and Hospitals Law InstituteFebruary 8-10,
2016
David Lewis Chris Carnahan Miller & MartinCarnahan Group
Presentation Outline Key Differences Between Fair Market Value
and Fairness OpinionsDrivers 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 IssuesCompleting the Deal Structure from Letter of Intent
to Full IntegrationTax Issues that May Impact the DealObtaining
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 buyerTerms: cash
or NPV of cashPurpose: value subject entity or assetPreparer:
independent expertPrepared for buyer and/or sellerActual
SellerSpecific Known Buyer or buyersTerms and conditions may
varyThe purpose is to provide stake holders with an
opinionIndependent expertPrepared 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 arms 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 partyacquisition, 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)
5
Valuation Overview
Three traditional approaches can be used to value an interest in
a closely held entity: Asset (cost) approachThe asset approach
considers the cost to reproduce or replace the property
appraisedReproduction 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 assetsMarket approach
Values are estimated by adjusting the prices that have been paid
for assets comparable to the asset being appraisedIncome
approachEstablishes 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, Contd
A fairness opinion takes into account important transaction
terms and circumstances including the acquirers 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 boards process for deciding
to abandon the traditional nonprofit hospital mission of the
corporation.
What Are Community Hospitals facing?
Capital ConstraintsGrowing IT Infrastructure
RequirementsHealthcareReform/Regulatory Uncertainty Decline in
AdmissionsIntegration of Healthcare ProvidersShortage of Physicians
and Healthcare Professionals
Major Pressures on the Health System
Credit Rating RequirementsEmployed Physician LossesUncertainty
about reimbursementSequestrationHealth Insurance ExchangeNo
Medicaid ExpansionOperating CostsCapital RequirementsRAC
AuditsICD-10Price TransparencyPayer Mix Change
Hospital Acquisition and Consolidation Models
Clinical AffiliationsFacility Management Agreements Joint
Operating CompaniesLong Term Leases Nonprofit Mergers and Member
SubstitutionsAsset 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 IntegrationLowHigh
Degree of Non-Profit ControlHighLowAffiliation Management
Services AgreementSale of Minority InterestJoint Operating
AgreementSale of Controlling InterestChange of Corporate
MemberSale/AcquisitionMergerEmerging Structures Joint
VentureTraditionalFor-Profit Transaction StructureJoint Venture
Examples of Minority Interest Joint Ventures
Minority Interest Joint Ventures
Source: Kaufman Hall
Collaborative Purchasing and Best PracticeManagement Services
AgreementJoint Operating AgreementAlternative 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, Contd
A JOC is formed according to the terms of a JOA, which is the
formal legal agreement defining the terms of combined
operationsSometimes 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 situationBuyer assumes control over hospital and physical
assets No conversion foundation (charitable foundation) needed
since any dollars remain with exempt entity
Asset Purchases, Contd
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, Contd
Not for Profit Sale to a For Profit
The purchaser buys the sellers 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 foundationKeeps any net
proceeds for the benefit of the community/to further the sellers
original mission
Asset Purchases, Contd
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 sellers hospital and physical
assets through stock or asset purchaseIn 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
ConsiderationsHealth 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 transactionGauge
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 needBoard committee Selection process (RFP,
networking, etc.)Letter of Intent Due Diligence Definitive
Agreement Approvals and NotificationsState licensing/CONAttorney
General approval
Assessing the Need to be Acquired Financial
ConsiderationsStrategic ConsiderationsImportance of MissionBoard
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 litigationCost Reports/RAC Audits Accreditation
Survey and licensure issues
Purchase Agreement
Timing of Execution/ClosingPrice, 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) Sellers representations and warranties Financial
Statements Taxes Recent material events Licenses Managed Care
Contracts and Medicare/Medicaid participationHealth Care
Compliance
Approvals and Notifications
Seek regulatory approval as the Purchase Agreement is reached
State regulatory approval licensure, CON, other state health
regulatory approvalHSR Notification if required (Antitrust/FTC)WARN
Act (employee termination) notices State Attorney General
approvalOther Approvals
Tax Issues that Impact the Deal
Maximizing shareholder value vs. public benefit and
goodDifferent consequences from different types of structuringWill
organizations tax-exempt status survive?Private foundations
Purchase price allocation differences
Local and Community Issues
Access to careAccess to similar level of servicesHospital
employment Economic multiplier effectCharitable
missionProfitability of service linesCultural 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
communityExamples 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 2006Notice 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 practiceAttorney 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 GeneralFind 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, Contd
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 largeNor have we forgotten
the cultural nuances of this region and the importance of cultural
sensitivity in the delivery of healthcare
Questions/CommentsThank you for the privilege of
presenting.Chris CarnahanDavid LewisCarnahan GroupMiller &
Martin PLLCPresidentChair, Health Care Practice Group5005 West
Laurel Street, Suite 204 401 Commerce Street, Suite 720Tampa, FL
33607Nashville, TN 37219(813) 289-2588(615) 744-8605
