Due Diligence in Distressed Community Hospitals

Standard diligence should consider the implementation of EHR/EMR. Electronic Medical Records (EMR) are digital versions of a patient's paper chart used within a single health care provider. An EMR system is built to go beyond standard clinical data collected in a provider's office and include broader view of a patient's care. Electronic Health Records (EHR) are individual health records which are shared among multiple facilities and agencies, and generally aren't a hospital focus. Not only must the hospital pay for any physical hardware and/or software, it must also expend funds for setup, maintenance, training, IT support and system updates. Cost alone may prohibit proper implementation.

There is a strong push toward “value-based payment models,” designed to link performance of quality measures to provider payment. Factors include reducing hospital readmissions, using certified health IT, and improving preventative care. The Department of Health & Human Services (HHS) set a goal of converting 50% of fee-for-service Medicare payments to value-based payment models by the end of 2018. Value-based payment models mandate that health care providers invest in technology and other capital improvements to increase efficiency and improve patient outcome.

Cash Flow Hurdles

Healthcare organizations track (“capture”) a patient's use of hospital resources, including equipment, medical supplies, diagnostic testing, medication and hospital staff. These charges are then billed to patients and third-party payers. The process behind “charge capture” can be complex and distressed entities may fail to have systems which completely and correctly capture all charges.

Medicare payments are unique and can re-open claims for four years. The federal government has the right to “recoup” any overpayments from current payments. As a general rule, courts cannot enjoin the exercise of recoupment. In Family Rehabilitation, Inc. v. Azar, __F.3d__ (5th Cir. 2018), the Fifth Circuit recognized a narrow exception, holding jurisdiction existed to enjoin Medicare recoupment during the administrative appeal process. A significant factor was the 2-5 year backlog of cases in the appellate process.

Other unique issues include:

• How effective has the hospital been in the structuring of “bundled” payments when compared to the actual costs of episodes of care?
• What is the count for “licensed” beds vs. the number of beds which could actually be occupied at “peak” capacity?
• What is the payor mix? What is the percentage of Medicare, Medicaid, third party insurance, high deductible patients, private pay and/or uninsured?
• Is there a history of underpayments, slow or delayed payments by third party administrators (TPAs) (which processes insurance claims or aspects of employee benefit plans)? Is the reimbursement rate similar to that of competitors?
• Is revenue being lost to ambulatory centers, outpatient facilities, area hospital systems or specialty clinics? Are the number and type of competitors increasing, changing or static?
• What is the status under the Hospital Readmissions Reduction Program which reduces reimbursement rates for “excess” patient readmissions?

Regulatory and Compliance Reviews

Given the highly regulated nature of hospitals, identifying regulatory and compliance issues is critical. The potential risks and liabilities imposed can be significant, resulting in detrimental impact long after the closing of a transaction.

There are numerous laws that could be implicated, but the “big four” set the stage — Anti-Kickback Statute (AKS), Stark Law (Stark), False Claims Act (FCA) and Civil Monetary Penalties Law (CMPL).

AKS makes it a criminal offense to offer, pay, solicit or receive anything of value to induce or reward referrals of healthcare services or goods payable by a federal health care program. Reviewing key documents, including, but not limited to physician contracts, marketing service agreements, management service agreements and documents showing physician ownership in a related business entity can be critical to identifying potential AKS violations.

Stark prohibits a physician or immediate family member of a physicians from making referrals of “designated health services” payable by Medicare to any entity in which the physician or immediate family member has a financial relationship, unless an exception applies. Similar to AKS, it is necessary to review all physician and other related documents that create a financial relationship, including, but not limited to, professional services agreements involving the physician, physician employment agreements, along with documents which relate physician ownership of business that is deemed a designated health service.

The FCA prohibits individuals from knowingly presenting or causing to be presented a false or fraudulent claim. It is both a standalone statute for inappropriate billing practices (e.g., submitting false claims to the federal government), and relevant if AKS is violated. The CMPL often goes hand-in-hand with the FCA.

It is a tool for the federal government to implement additional penalties for inappropriate conduct including submitting false claims, providing for services beyond medical necessity or breaching Medicare conditions of participation. In recent years, the concept of “reverse FCA” violations are being explored by the federal government, e.g., if a hospital fails to return an identified overpayment within 60 days. Throughout due diligence, evaluating collection and claims processes and procedures will be vital. If questionable billing or collection practices are identified, initiating a billing and coding audit by an independent third party may be appropriate.

Beyond the “big four” issues, a potential investor should consider ancillary issues including HIPAA practices, licensing and certificate and corporate practice of medicine (CPOM). CPOM jurisdictions restrict employment of physicians by non-physicians. Any arrangement where non-physicians have financial stakes or are in a position to dictate physician clinical decisions should be identified. HIPAA policies, business associate agreements, pending corrective actions and enforcement actions by HHS Office of Civil Rights should also be addressed. It will be critical to identify change of ownership restrictions and timeframes for applicable licenses and certificates, along with the history of citations or penalties associated with licenses and/or certificates. If regulatory violations have been identified, self-disclosure and a resolution with the government may be an option.

Governmental Claims

Police and regulatory powers are not stayed even in a bankruptcy. A transfer of a hospital is generally accompanied by the Medicare and Medicaid Provider Agreement, with attendant successor liability for government claims. Due diligence requires a determination whether there are any ongoing state or federal investigations.

A qui tam lawsuit is one brought by a private citizen (popularly called a “whistle blower”) against a person or company believed to have violated the law in the performance of a contract with the government or a government regulation. In a qui tam action, the plaintiff will be entitled to a percentage of the ultimate payment as a reward for exposing the wrongdoing and recovering funds for the government. The government can intervene and become a party to the suit in order to be part of any negotiations and conduct of the case. Qui tam litigation can be pursued, even if the government declines to prosecute. In 2018, the DOJ issued a memorandum re-urging its attorneys to seek dismissal of “meritless” qui tam litigation over the objection of the realtor. It remains to be seen if this or other actions put a damper on such claims.

Opportunities

Many hospitals and other providers are attempting to increase revenues by providing additional services (e.g., home health care, long-term care or rehabilitation). The value-based payment model favors this horizontal integration. The economies of scale for larger systems are significant, and capital-constrained hospitals and hospital systems have struggled to keep up.

Can a “walk in” or outpatient facility adjacent to the hospital be created? These facilities are more efficient at dealing with the minor cuts and scrapes, sniffles, sneezes, flu, and the like. They also keep patients out of the emergency room. More importantly, there is a better payor mix, as patients pay upfront to the extent the facility is not bound by the EMTLA. They can also be a feeder for hospital system.

Exit Issues

If a sale is anticipated, will there be approval issues? Certificate of Need (CON) programs regulate the number of beds in hospitals. For example, in Delaware in 2014, a CON was passed that prohibited the establishment of any new hospitals offering medical/surgical or obstetrical beds for five years. Texas, by contrast, has no CON requirements. The National Conference of State Legislatures outlines states CON programs.

Is the hospital owned by a hospital district? If so, what additional consents would be required to consummate the transaction? In a non-profit, the attorney general acts as the “equity,” serving the public's interest and must consent to a sale to a “for-profit” entity. The degree of activity by any attorney general depends on the size of the facility and approach taken by each state.

Is there a regional reconfiguration plan? A regional reconfiguration plan is a deliberately induced, non-trivial change in the distribution of services that are available in each hospital or other secondary or tertiary acute care unit in a locality, region or health care administrative area. They are more common in states with CON requirements. If one exists, will that impact projected revenues, CAPEX and other issues? Are there interim funding sources from a governmental entity?

If the exit includes closing of a hospital, due diligence takes on another dimension. Questions to be asked include:

• Is there a pharmacy? If so, is it owned by the facility or operated by a third party?
• Is there a fragile patient population? If so, how long will it take to transfer all patients? How long will it take to stop admitting new patients?
• Is there an emergency room? If so, what is the process for diversion?
• Is there leased equipment? Can the equipment be moved?
• Who will take responsibility for the patient records? What is the cost for storage of records? Who will notify former patients regarding the location of their records?
• Are there land use restrictions? Can any restrictions be easily modified?
• Will the property need to be re-zoned?

Analysis

There will always be a need for well-run community hospitals. Through due diligence, a distressed community hospital can become a viable investment. Failure to identify and address the issues unique to community hospitals can lead to interminable buyer's remorse.

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Deborah Williamson ([email protected]) is a member of Dykema's Bankruptcy, Insolvency & Creditors' Rights Practice Group and has been named one of the top five bankruptcy attorneys in the State of Texas. Mark Andrews ([email protected]) is the practice group leader of Dykema's Bankruptcy, Insolvency & Creditors' Rights Practice Group. Richard Y. Cheng ([email protected]) is a member of Dykema's Healthcare practice group.