Legal Issues for 2010

The ambulatory surgery center industry (ASC) confronted both challenges and change in 2009. However, with numerous ASC developments underway and an economic recovery on the horizon, the ASC industry is poised to perform well in 2010. This article addresses the key business and critical healthcare regulatory developments of this past year and their potential impact on the ASC industry for 2010.

Sale to ASC Management Companies and Health Systems

A significant business issue confronted in 2009 by the ASC industry was the decline in transactions involving a sale of a significant equity interest in an ASC to an ASC management company or health system. This decline was likely precipitated at least in part by a few historical ASC management companies that slowed down their acquisition strategies due to the tightened credit market.

In addition, the terms and pricing associated with a sale of a significant equity stake in an ASC clearly changed. For the past few years, many ASC management companies and health systems were willing to acquire a controlling equity interest in an ASC for a 7-plus purchase price multiple. Most purchase price multiples have dropped into the 5-6 range.

The purchase price formula is typically calculated as follows: (i) the ASC’s earnings before interest, taxes, depreciation and amortization (EBITDA) for the prior twelve months; multiplied by (ii) the purchase price multiple (e.g., 5-6 range); less (iii) the ASC’s long-term liabilities; multiplied by (iv) the ownership percentage being purchased. For example,. assume an ASC with $800,000 in EBITDA and no long-term debt desires to sell a 51 percent interest to an ASC management company, then the purchase price could range from $2 million to $2.5 million (e.g., [($800,000 x 5 to 6) – $0] x 51 percent).

Some new well-funded corporate buyers have also emerged in 2009. Additionally, hospitals continue to have an appetite for ASC acquisitions. As a result, a slight uptick in these transactions can be anticipated for 2010. While purchase price multiples will likely hover in the 5-6 range, ASC companies have also introduced more creative strategies to make deals more attractive to selling physicians, including the use of earn-outs and staged transactions. These strategies warrant careful attention as they can introduce new healthcare regulatory and other legal issues into the mix.

Hospital/Physician Alignment Options and Changes to the Stark Law

Hospitals and health systems will likely continue to leverage their higher reimbursement rates and community branding as a means to attract ASCs to them over other corporate investors. Historically, some hospitals pursued an “under arrangement” transaction strategy with physicians in an ASC setting.

While the terms of an “under-arrangement” transaction can vary considerably, it typically involves a physician-owned company leasing the space, equipment and/or staff to the hospital — perhaps on a turn-key basis. The hospital bills Medicare and other payors for the services and pays the physician-owned entity a fixed fee, variable fee or hybrid fixed/variable fee.

However, Stark law changes that became effective as of Oct. 1, 2009 forced hospitals and physicians to restructure or unwind such arrangements. In particular, the scope of the Stark law was expanded to apply not only to the entity billing for a “designated health service” (i.e., the hospital) but also the entity that is performing the designated health service (i.e., the physician-owned entity). In addition, the Stark law no longer permits a physician owned entity to lease space or equipment on a per-click, percentage of revenue or other similar fee structure.

In what appears to be an emerging trend across the country, a number of health systems are also considering (or for many — reconsidering) a broad spectrum of hospital/physician alignment and integration options including physician practice acquisitions, use of the foundation model, and entering into professional service and employment arrangements with surgeons and other proceduralists. These strategies may be driven at least in part by the changes to the Stark law as well as the mutual desire of hospitals and physicians to collaborate in the provision of healthcare services in a more meaningful and long-term manner.

Migration of Procedures From Hospitals Into the ASC

At the individual ASC level, in spite of a slight decrease in demand, many ASCs have grown their profits. The revenue growth may be due in part to the movement into the ASC of procedures historically required to be performed in the hospital setting, such as vascular access and certain orthopedic procedures.

The emergence of these procedures new to the ASC setting has been primarily driven by advances in medical technology as well as the expanded list of Medicare ASC covered procedures under the revised ASC payment system. Adopted by the Centers for Medicare and Medicaid Services in 2007, the revised ASC payment system allows an ASC facility fee to be paid for any surgical procedure performed at an ASC, except those surgical procedures that CMS determines are either not safe when furnished in an ASC or in which the expected duration of services would exceed 24 hours following admission.

The addition of these procedures to an ASC can have an immediate positive impact on an ASC’s bottom-line. As a result, many ASCs are examining the viability of adding these procedures to their ASC by attracting the appropriate physician specialists and sub-specialists and properly equipping the facility for such procedures.

Physician Re-Syndications

Physician re-syndications (i.e., sale of equity interests to physicians) remain very active for a number of reasons. First, ASC companies and physician owners of ASCs often desire to solidify physician utilizers’ relationships to their ASC by having them purchase equity interests. Second, a number of ASCs are reselling equity that was repurchased from prior physician investors who are no longer utilizing the facility.

Many ASCs, however, are struggling with how to make the buy-in price to physicians more attractive. The purchase price must be consistent with fair market value to minimize anti-kickback law issues. The purchase price formula for a physician’s purchase of a minority interest is the same as the formula used by an ASC management company, except that a 2-4 purchase price multiple is typically used in lieu of the 5-7 multiple. The buy-in, however, can still be quite significant. For example, assume the same ASC, as previously mentioned, desires to sell to a 5 percent equity interest to a physician, then the purchase price could range from $80,000 to $160,000 (i.e., [($800,000 x 2 to 4) - $0] x 5 percent) Allowing the ASC or its owners to loan monies to the physician to buy-in, including through an advance of future ASC distributions, could raise regulatory concerns. Accordingly, an ASC may consider alternative strategies to make the purchase price more affordable. These strategies may include the use of a dividend recapitalization or preferred distribution (which are treated as a liability in the formula described above thereby reducing the purchase price).

Alternatively, an ASC could undergo a tax-free restructuring so that the ASC is owned through a physician group practice. Group practice ownership of an ASC may allow an ASC to depart from a fair market value buy-in price.

Physician Buy-Backs

Many ASCs continue to be confronted with physician partnership and “deadweight” issues. A recently filed lawsuit, DeBartolo v. HealthSouth Corp. brings to the forefront the issue of non-productive physician owners in ASCs. The lawsuit was filed by a surgeon investor in an ASC whose shares were repurchased because of his failure to perform at least one-third of his procedures at the ASC.

The case is significant because it addresses the critical issue of whether the repurchase of a physician’s equity interest for failing to utilize the ASC would violate the anti-kickback law. On the one hand, the federal anti-kickback law ASC safe harbor mandates that a physician must perform at least one-third of his procedures at the multi-specialty facility in which he has an ownership interest. However, regulatory concerns could also arise if an ASC’s redemption of a non-productive physician is intended to penalize the physician for not selecting this particular facility for the procedure.

Nevertheless, many ASCs have incorporated compliance with the one-third test requirement into their governing documents. If a physician owner fails to perform at least one-third of his or her ASC procedures at the ASC in which he or she is an owner, then the ASC’s governing document may provide that such physician’s ownership interest in the ASC can be repurchased by the ASC or its other owners.

In an early ruling in DeBartolo, the federal court dismissed the lawsuit indicating it should be addressed under state law. While too early to determine, this initial ruling suggests that physician buy-back issues may simply raise state contract law claims. It is therefore critical that an ASC’s governing document incorporates the latest terms and mechanisms for dealing with physician equity buy-backs in a manner that takes into account the latest regulatory and other legal guidance.

Conclusion

There is no denying that this past year was a bit sluggish for the ASC industry, particularly in the transactional front, as it faced its own set of challenges including dealing with aggressive payor “out-of-network” billing strategies and the potential impact of health system reform. However, most ASCs escaped generally unscathed from the economic woes of this past year.

As 2010 gets underway, there are a number of favorable indicators for the ASC industry. Newly emerging buyers with capital are in search of ASC acquisition opportunities. Hospitals remain interested in pursuing collaborative strategies with physicians, particularly in the ASC and other outpatient sectors. And, ASCs are adopting a number of revenue enhancement strategies including through performing procedures not historically performed in the ASC setting, physician re-syndications and by adding ancillary revenue streams (e.g., anesthesia). As a result, the ASC industry is poised to have a strong year in 2010.

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