RECENT CASES OFFER INCREASED PROSPECTS FOR MERGERS BY COMPETING HOSPITALS

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1 RECENT CASES OFFER INCREASED PROSPECTS FOR MERGERS BY COMPETING HOSPITALS July 19, 2016 Recent setbacks experienced by the Federal Trade Commission (FTC) in hospital merger challenges may embolden hospitals and health systems considering potential combinations, especially in light of the need for coordinated care under the Affordable Care Act. The following is a summary of recent developments. FTC Drops Challenge to Merger between West Virginia Hospitals On July 6, the FTC voted unanimously to dismiss its challenge to a proposed merger between Cabell Huntington Hospital and St. Mary s Medical Center in Huntington, West Virginia, as a result of the enactment of a new state law and the West Virginia Health Care Authority s resulting approval of a cooperative agreement between the two hospitals. The FTC had challenged the proposed merger in November In March 2016, the state approved the new law providing for cooperative agreements and exempting health institutions monitored by the state healthcare agency from federal antitrust scrutiny if the state agency signed off on the arrangement. Such laws have been enacted or considered in several other states and generally seek to replace federal antitrust enforcement with state regulation and supervision of healthcare provider combinations. Our People Beth E. Vessel Industries Served Hospitals & Health Systems Healthcare Legal Services Corporate Healthcare Healthcare Mergers & Acquisitions The FTC had challenged the proposed merger, claiming that it would give the resulting hospital a near monopoly over general acute inpatient hospital and outpatient surgery services in Cabell, Wayne and Lincoln County, West Virginia and Lawrence County, Ohio, resulting in higher prices and lower quality care. The new state law, S.B. 597, made the West Virginia Health Care Authority the sole decision maker with respect to healthcare provider consolidations. On March 24, the FTC withdrew the matter from adjudication for 30 days, and on April 22, the withdrawal from adjudication was extended until the end of the 14 th calendar day after issuance of a written decision with respect to the cooperative agreement by the West Virginia Health Care Authority. The FTC issued its written decision approving the cooperative agreement on June 22. This result might indicate more of a willingness to allow potentially competitive combinations, in an effort to effect the policy goals of the Affordable Care Act, such as the proposed Mountain States/Wellmont combination currently under state review in Tennessee and Virginia. However, the FTC said in its statement on July 6 that cooperative agreement laws actually undermine the

2 policy goals of the Affordable Care Act to improve quality and lower costs and emphasized that the ACA did not repeal the antitrust laws. The FTC went on to state that many of the purported benefits of hospital mergers including coordination of patient care, sharing information through electronic medical records, population health management, risk-based contracting, standardizing care and joint purchasing can often be achieved through alternative means that do not impair competition. The FTC vowed to continue to investigate and challenge anticompetitive mergers and said that its decision to dismiss this particular complaint without prejudice does not necessarily mean that it will not raise challenges in other cases in which a cooperative agreement is sought or approved, as such arrangements are unlikely to replicate the benefits of competition. Illinois Federal Judge Rules that FTC Cannot Block Chicago Hospital Merger On June 14, 2016, a U.S. District Court in Illinois ruled that the FTC could not block the merger of Advocate Health Care and NorthShore University Health System based on evidence presented during a week-long hearing, holding that the FTC had not provided sufficient evidence that the partnership would harm competition in the region. The FTC had argued that the transaction would threaten competition in Chicago s northern suburbs, with the merged entity controlling six out of the 11 hospitals in the area. The hospitals said that the government s market definition was too small and failed to consider how far patients will travel to receive inpatient hospital services, and stated that the merger would reduce costs for patients by moving NorthShore onto Advocate s more efficient healthcare management system. The FTC sued to stop the merger, which was announced in 2014, in December According to the complaint, the combined entity would control more than 50 percent of the general acute care inpatient services in the market. The FTC has appealed the district court ruling to the Seventh Circuit, and a motion for an injunction pending the appeal was granted. On June 28, the parties agreed that an evidentiary hearing in the FTC s administrative proceeding would commence 21 days after the Seventh Circuit ruling on the FTC s appeal. Pennsylvania District Court Denies Injunction against Penn State Hershey Medical Center and PinnacleHealth System Merger On May 9, the Middle District of Pennsylvania denied the FTC s and Commonwealth of Pennsylvania s motion for a preliminary injunction against the consummation of the proposed merger of Penn State Hershey Medical Center and PinnacleHealth System, pending the completion of the FTC s administrative trial on the merits of the transaction. The court rejected the FTC s request, finding that the geographic market definition suggested by the FTC was

3 unrealistically narrow, as a substantial number of patients of both facilities either reside in or travel to the hospitals from locations outside of the Harrisburg area, the FTC s suggested market. The court held that 19 other hospitals within a 65 minute drive of Harrisburg provide a realistic alternative for patients. The decision went on to criticize the FTC, expressing the view that the FTC s position could be considered ironic given that the federal government has created a climate that virtually compels providers to seek alliances similar to what the hospitals were seeking. The FTC has appealed the decision to the Third Circuit. One June 20, the parties agreed that an evidentiary hearing in the FTC s administrative proceeding would commence 21 days after the Third Circuit ruling. Penn State Hershey Medical Center and Pinnacle signed a letter of intent for a proposed merger in June Following a nine-month investigation, the FTC filed administrative and civil complaints to block the transaction in December 2015, asserting that the merged entity would control approximately 64 percent of the hospital market in Dauphin, Cumberland, Perry and Lebanon counties, which would likely lead to increased costs and reduced quality of care. The separate action in district court was also filed to block the merger on the grounds that it would substantially reduce competition in the market for general acute acre inpatient services sold to commercial health plans and their members. In addition to rejecting the FTC s market definition, the district court ruling discussed proposed efficiencies which might result from the merger. In particular, the court was impressed with the fact that the hospitals had executed long-term contracts with two of the biggest payors in the market, locking in existing rates for fee-for-service contracts and preserving rate differentials between the facilities for five and 10 years, respectively. The court stated that it refused to block a merger based on predictions of what might happen several years after such restrictions expired. The court noted that Hershey needed additional capacity and could receive immediate benefits from the merger, avoiding the need for large capital expenditures to expand. The court also treated other facilities in the market which had repositioned their product lines as new entrants and noted that the merged entity would be better able to spread out expected costs of population health management needed for risk-sharing arrangements. Notably, the court stated that the decision recognized a need to adapt to an evolving landscape of healthcare that includes the institution of the Affordable Care Act, fluctuations in Medicare and Medicaid reimbursement and the adoption of riskbased contracting, and said that the ruling reflects the healthcare world as it is, not as the FTC wishes it to be. Some courts seem to be taking more note of the changing environment than the FTC, as reflected in recent decisions. Other Recent Developments

4 There have also been recent cases involving anticompetitive effects of contractual relationships, involving payor agreements and joint operating agreements executed by competing hospitals. These cases provide insight into material considerations with respect to contractual arrangements with payors and among competitors. Ongoing Challenge of Carolina Health System s Use of Steering Provisions in Managed Care Contracts On June 9, 2016, the Department of Justice and the State of North Carolina filed suit in the Western District of North Carolina seeking an injunction to prevent Carolinas Health System from continuing to require steering restrictions in its payor contracts. Carolinas has a 50 percent market share in Charlotte, and the complaint alleged that its market power results from its large size, the comprehensive range of services it offers and insurers need to include access to its facilities in at least some of their provider networks covering patients in the Charlotte area. The complaint went on to allege that the health system has required steering restrictions in its contracts with insurers that impede insurers from providing financial incentives to patients to encourage them to consider utilizing lowercost but comparable or higher-quality alternative providers. Specifically, Carolinas has prevented insurers from offering tiered networks that feature hospitals that compete with Carolinas facilities in top tiers (with lower premiums and out of pocket costs) or from offering narrow networks that include only competitors of Carolinas. Because such restrictions prevent competitors from attracting patients through lower prices, competitors have less incentive to lower prices or become more efficient, and competition in the market is allegedly reduced. The complaint relies on the allegation that an insurer selling health plans in the Charlotte area must have a Carolinas facility as a participant in at least some of its provider networks in order to have a viable health insurance business in the Charlotte market. Because building a hospital with a strong reputation is difficult, time consuming and expensive, and new facilities and expansions of existing facilities are subject to lengthy licensing and certificate of need requirements, entry by other competitors does not counteract the likely competitive harms resulting from the steering restrictions. The complaint goes on to allege that any arguable benefits of the steering restrictions are outweighed by their actual and likely anticompetitive effects. Lawyers representing Carolinas have indicated that the system will vigorously defend the suit, claiming that the health system is being sued for something that takes place on a regular basis across the country. The results of this lawsuit will likely effect the conduct of dominant providers in other markets. Sixth Circuit Reinstates Challenge to Hospital Joint Operating Agreement In March of 2016, the Sixth Circuit reversed a district court finding

5 and held that a complaint alleging anticompetitive conduct by a group of hospitals in the Dayton, Ohio area, collaborating through a joint operating agreement, could proceed under Section 1 of the Sherman Act. A physician-owned hospital in Dayton filed the suit alleging that an operating company, Premier Health Partners, and participating hospitals harmed competition by entering into network contracts with commercial insurers on the condition that new hospitals be kept out of the network. The district court had ruled that the venture was a single entity and its actions could therefore not violate Section 1, as Section 1 does not proscribe unreasonable restraints on trade by a single entity. The Sixth Circuit reversed and held that the record raised a genuine issue of material fact as to whether the hospitals should be considered a single entity for purposes of the antitrust laws. In this case, previously independent hospitals were operating as a hospital network and had entered into the joint operating agreement merging some of their functions, while the individual hospitals retained others. The plaintiff hospital offered proof that the group engaged in concerted action by coercing commercial health insurers representing at least 70 percent of the market to refuse to negotiate contracts with the plaintiff hospital, by threatening punitive financial consequences to physicians who affiliated with the plaintiff hospital and by compelling physicians to refuse to admit patients to the plaintiff hospital. The court first looked to the actual conduct of the parties, rather than to the structure and organizing documents of the venture, and found the intention to keep the plaintiff hospital from entering the market. The court then discussed the business relationships as reflected in governing documents and concluded that, while there was some degree of unitary management, questions remained as to whether the hospitals retained their separate corporate consciousness. The court focused on evidence that the hospitals remained separate legal entities, held their own assets, filed their own tax returns, competed with one another for physicians and patients, marketed certain hospital service to the public and made material independent decisions concerning their respective operations. The court noted that the fact that the venture required hospital revenue sharing under an agreed formula was insufficient to create single-entity status. Such ventures will presumably face a fact-intensive level of scrutiny to determine if conduct among competitors is concerted or unilateral, and the results of the case on remand may provide additional insight. This decision likely increases the potential risk of antitrust liability relating to joint venture relationships, in which hospitals may attempt to enjoy the benefits of a merger without actually consolidating management or combining asset ownership. For additional information, please contact Beth Vessel in Waller's Healthcare department at

6 The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.