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