Hospital-Physician Joint Ventures – Compliance Checklist for Governing Board

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Corridors - News for North Carolina Hospitals

04.01.2007

Wilson Hayman

Declining reimbursement and rising malpractice and other costs have been pressuring physicians for years to seek alternative sources of revenue for their practices. Such potential profit centers for physicians have included ambulatory surgery centers, freestanding diagnostic centers for imaging or endoscopy, and oncology treatment centers, often with the assistance of outside, for-profit management companies. Such freestanding centers appeal to patients by generally providing less costly, more efficient and convenient care. However, hospitals see this competition and the resulting loss of profitable procedures as a potential threat to their economic viability and their ability to serve all citizens regardless of ability to pay. To avoid a significant loss of this revenue, many hospitals have sought to form joint ventures with physicians, even though such ventures often furnish the same services the hospitals themselves can generally provide on an outpatient basis at a higher level of reimbursement.

While such hospital-physician joint ventures can prove mutually beneficial to both parties in many respects, they pose a number of regulatory hurdles which must be crossed in order to avoid a risk of serious penalties to the hospital. In particular, federal and state fraud and abuse laws impose important limitations on physician ownership of such facilities. Moreover, since most community hospitals in North Carolina are 501(c)(3) organizations, the requirements for tax-exempt entities also dictate to some degree the structure of such arrangements for these organizations. If a hospital is considering such a joint venture, the hospital’s governing board has a responsibility to educate itself on these issues, to consider and evaluate the advice provided by administration and its advisers, and to ask questions where necessary to fully explore the benefits and risks of the planned course of action.

A checklist for the governing board of a hospital exploring a hospital-physician joint venture would inevitably include the considerations listed below.

Fraud and Abuse Laws - Medicare and Medicaid Anti-Kickback Statute. The arrangement should comply, or come close to complying with, the following regulatory safe harbors under the Anti-Kickback statute.

Physician investment should, if possible, come within the safe harbor for investment interests in small entities, which, among other things, limits to 40 percent the equity that may be held by physician investors in a position to make referrals to, furnish services or items to, or generate business for the entity.

The arrangement meets the safe harbor for ambulatory surgery centers (“ASCs”), one of which pertains to ASCs owned by a hospital and physicians. The requirements of that safe harbor include that (1) at least one-third of each physician investor’s medical practice income from all sources for the previous year were derived from the physician’s performance of procedures eligible to be performed within an ASC; (2) at least one-third of those “ASC eligible” procedures will in fact be performed by each physician investor in the proposed ASC; (3) the entity and any physician investors must treat patients receiving benefits under a federal health care program in a nondiscriminatory manner; and (4) physician-owners must disclose their ownership interest to their patients at the time they are referred to the entity.

Any management fee should satisfy, or come close to satisfying, the requirements of the safe harbor for personal services and management contracts, including that the aggregate compensation is set in advance, consistent with fair market value in arms-length transactions, and is not determined in a manner that takes into account the volume or value of any referrals or business generated between the parties.

In its Fraud Alert on Joint Ventures and a Special Advisory Bulletin on Contractual Joint Ventures, the Office of the Inspector General of the U.S. Department of Health and Human Services (“OIG”) has identified certain sensitive issues or “red flags” concerning joint ventures. These include joint ventures with physician or other referral sources in which the share of investment that investors are offered correlates to expected referrals; requirements that investors can be divested of their interests if they fail to refer; and contractual joint ventures in which physicians contract with an existing provider which “manages” the new business, while the business depends on referrals from the physician owners.

N.C. Anti-Referral Statute - The North Carolina anti-referral statute prohibits a physician or group practice from making referrals of care provided under a state-regulated health benefit plan to an entity in which that physician or a member of his or her group is an investor. However, the statute excepts from the prohibition any service that is provided by, or under the personal supervision of, the physician or a member of his or her group practice to the patients of that physician or group.

Law of Tax-Exempt Organizations - The IRS has also scrutinized joint ventures between tax-exempt hospitals and physicians or other for-profit entities and has sanctioned hospitals when it found that participation endangered the hospitals’ tax-exempt status. Thus, the governing board of an exempt hospital has a duty to ensure that these requirements have been met. Some of these considerations include the following.

Participation must further a charitable purpose of the hospital, such as assistance to the poor, advancement of education or promoting health to a broad section of the community. The community benefits and charitable purposes of the venture should be stated in the new entity’s governing documents.
The structure of the venture should provide no private inurement to “insiders,” which the IRS has viewed in the past as including any physician on the hospital’s medical staff. Any benefit conferred through the venture on private, for-profit partners must be solely incidental to the community benefits provided through the venture.
Board representation must be proportionate to ownership. However, in order to ensure that the venture will engage primarily in activities that further charitable purposes, the hospital must either (1) control the governing board of the joint venture entity, (2) retain more than 50 percent control, or (3) have voting power of at least 30 or more percent with reserve powers over certain decisions of a major nature and which affect the venture’s community benefit, such as the provision of care to charity, Medicare and Medicaid patients. The charitable purposes should override any duty of the venture’s governing board to maximize profits for the financial benefit of the owners.
Income from the venture should be based on the relative contributions of the parties rather than “sweat equity,” and the venture should not make special allocations of tax benefits to the physicians.
The hospital should not finance the acquisition of the interests of physician parties to the venture. Nor should it have a disproportionate exposure to liability, such as a guarantor of a disproportionate share of any loan to the venture.
Beware ventures which do not establish any new facilities or services but involve the hospital’s contribution of existing “net revenue streams” to the venture, thus generating inurement and private benefit with little benefit to the public.
Any management agreement should be for a reasonable term, with reasonable provisions for termination and renewal (i.e., the management company may not unilaterally renew). Control over the venture’s charitable purposes may not be ceded to a third party, for-profit manager.
The structure and basic terms of the joint venture’s governing instruments must be approved by the hospital’s governing board on an independent and contemporaneous basis.
Valuations should be performed by an independent appraiser contemporaneously with the transaction, preferably before the negotiation of a price or entering into a letter of intent that includes the price.

Reimbursement - Explore alternative structures which may affect the level of reimbursement and the attendant risks associated with the same. For example, an ASC located within 250 yards of the hospital and which meets certain requirements of integration with the hospital can be considered “under arrangements” and treated as a hospital outpatient department for billing purposes. Such an ASC could receive the higher Medicare reimbursement rates for hospitals rather than ASC rates.

Certificate of Need - The N.C. Certificate of Need law requires that a certificate of need (“CON”) be issued by the N.C. Department of Health and Human Services prior to the offer or development of a “new institutional health service.” Services requiring a CON include ambulatory surgery centers, GI endoscopy rooms, certain diagnostic centers, the purchase of medical equipment costing (along with any plans and activities required to make it operational) more than $750,000, and the purchase of certain identified medical equipment such as an MRI scanner, PET scanner or linear accelerator. The regulatory restrictions placed on a hospital’s ability to enter into joint ventures with physicians are significant, and the hospital’s governing board plays a key role in assessing the risks and benefits of such a proposal and in assuring compliance. If the parties are reasonable and remain sensitive to these issues, however, such undertakings can and do prove to be a “win-win” for all parties.

Physical Address: 301 Fayetteville Street, Suite 1900, Raleigh, NC 27601

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04.01.2007