Joint Operating Agreements in Healthcare

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Joint Operating Agreements in Healthcare Complying With Regulatory Requirements and Maintaining Tax-Exempt Status in Structuring Virtual Merger Arrangements TUESDAY, JUNE 4, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Elizabeth M. Mills, Senior Counsel, Proskauer Rose, Chicago Jan Murray, Of Counsel, Foley & Lardner, Boston The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

2 Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory and you are listening via your computer speakers, you may listen via the phone: dial and enter your PIN when prompted. Otherwise, please send us a chat or sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

3 FOR LIVE EVENT ONLY For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps: In the chat box, type (1) your company name and (2) the number of attendees at your location Click the SEND button beside the box

4 If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the lefthand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

5 Joint Operating Agreements: Back to the Future 5 Jan E. Murray Foley & Lardner Boston, MA jemurray@foley.com Attorney Advertising Prior results do not guarantee a similar outcome Models used are not clients but may be representative of clients 321 N. Clark Street, Suite 2800, Chicago, IL

6 Agenda Pressures Driving Hospital Affiliations Range of Hospital Affiliations: Mergers, Acquisitions, Joint Ventures and Joint Operating Agreements (JOA) Definition of JOA Differences among Affiliation Models Tax and antitrust considerations in forming and operating JOAs Other legal issues in forming and operating JOAs Pitfalls of JOAs Strategic and practical considerations 6

7 Pressures Driving Hospital Affiliations The healthcare industry is undergoing a period of fundamental transformation in which the very model of healthcare delivery is being questioned and changed. Moody s Investors Service (quoted in American Hospital Association (AHA) Fundamental Transformation of the Hospital Field, 2012) 7

8 Pressures Driving Hospital Affiliations Health care reform forcing increasing collaboration among hospitals, physicians and other providers Limited access to capital Particularly for non-profits, capital markets have not fully recovered from financial meltdown In addition to other capital needs, IT requirements are expensive to fund 8

9 Pressures Driving Hospital Affiliations Reimbursement pressures According to industry analysts, the median hospital revenue growth rate is the lowest in two decades Moody s rated hospital outlook as negative for at least next several years in (Moody s Investors Service, quoted in AHA publication, Fundamental Transformation of the Hospital Field, 2012) 9

10 Increasing Consolidation According to the AHA Trendwatch Chartbook 2013 the number of hospitals in hospital systems has grown steadily from (nearly 3,000 hospitals up from under 2600 in 2001); and The number of hospital M&A deals has increased in every year from (90 announced deals) 10

11 What Does All This Mean? In addition to the increase of hospital mergers, other forms of hospital transactions are also increasing. According to [AHA] data, while the number of hospitals has only marginally increased since 1999 (up less than 1%), the number of hospitals affiliated with a system has increased 16%...This means that while the number of hospitals is not growing, the number of health system affiliations is rising, highlighting the trend of existing hospitals to consolidate in some way. (Dixon Hughes Goodman, What Hospital Executives Should be Considering in M&A ) 11

12 Increasing Consolidation First quarter of 2013 has seen some slowdown in M&A activity; 23 deals down from 34 in last quarter of 2012 Activity picking up at end of first quarter though and is expected to rise when effects of sequestration are better known (FierceHealth Finance, Healthcare M&A Tumbles, 4/26/2013) 12

13 Range of Hospital Transactions Forms of hospital consolidation can take the form of loose affiliations all the way to absorption of an entity by acquisition Joint Operating Agreements (JOA) lie on the looser end of the spectrum somewhere above an affiliation or joint venture but below mergers and acquisition 13

14 Range of Hospital Affiliations Affiliation/Joint Venture Typically either by contract or by creation of a NewCO that has limited purpose (e.g., joint purchasing only) Merger/Acquisition Two corporations combine with one surviving For profit: may occur by purchase of shares of an entity Non profit: typically occurs by substitution of a member Alternative: Purchase of assets Consolidation Merger of two entities into a new entity 14

15 Joint Operating Agreement Definition Typically involves the formation of a new entity, super parent, by existing hospitals seeking to affiliate and is jointly owned by existing hospitals Existing hospital corporations and boards remain intact with certain powers that may still be exercised Contrast to merger/acquisition where a subsidiary or the surviving shell corporation is absorbed and wound down or treated as mere operating division Super parent is given certain obligations and powers to manage certain aspects of the whole enterprise 15

16 Joint Operating Agreement versus Merger Powers of the parent in merger-type transaction if wholly owned sub survives Structural and actual control ceded to new parent which: Appoints and removes board members Approves amendments to articles or bylaws Authority over asset transfers, budgets and strategic plans Approval of mergers, acquisitions or affiliations of subsidiaries 16

17 Joint Operating Agreement versus Merger Hospital boards maintain some level of autonomy in JOA in relation to a super parent which may or may not be a passthrough entity Significant variances can exist among JOAs with respect to sharing of responsibility for governance/management issues IRS analyzes control under facts and circumstances to determine whether the dealings under the JOA are merely matters of accounting between related organizations rather than rising to the level of unrelated trade or business (See Darling R., Friedlander M., Virtual Mergers Hospital Joint Operating Agreement Affiliations, 1997 EO CPE Text) 17

18 Joint Operating Agreements Financial Matters Revenues of hospital corporations flow to parent Joint contracting for managed care takes place through parent Over time, debt may be secured by parent 18

19 Shared Governance and Management Features in JOA Hospital boards may maintain responsibility for religious directives Hospital entities continue to own assets Local hospital boards and management may direct some local services Some local level of budget authority may be exercised by Hospital Boards May appoint, remove some board members 19

20 Joint Operating Agreement versus Merger If JOAs are designed to permit negotiating jointly with managed care companies then must meet certain requirements from an antitrust standpoint If JOA parent is to receive tax exempt treatment and/or avoid UBIT on transfers of revenue from hospital members, must meet certain IRS requirements. 20

21 Why do JOA rather than Merger? Preserve special mission in system e.g., religious directives Avoid legal restrictions arising from public status i.e., permit public hospital to be joined in system Permit joint action without surrendering complete independence 21

22 Joint Operating Agreements in Healthcare Elizabeth M. Mills, Esq. Senior Counsel Proskauer Three First National Plaza 70 West Madison Chicago, IL (312) June 4,

23 Federal Income Tax Exemption Issues 23

24 What's The IRS Got To Do With it? Section 501(c)(3) tax-exempt organizations must operate for exempt purposes 501(c)(3) organizations can endanger their exemption if they conduct a trade or business unrelated to exempt purposes ("UBI") as a substantial part of their activities 501(c)(3) organizations can't share profits with non-exempt entities or provide an equity-type interest to non-exempt entities With very limited exceptions, tax-exempt bond-financed property can't be used, occupied, or owned by non-exempt entities - Or by tax-exempt organizations in UBI activities 24

25 Why do they care about control? "Actual" hospital merger - Hospitals are brought together under common tax-exempt parent - Parent exercises structural control through director appointment and reserved powers - Related organizations are an "integral part" of each other and can share services and management without UBI 25

26 Joint Operating Company Delegated Hospital Board Selection Parent A Appoint JOC directors Reserve powers over JOC organic changes Parent B Joint Operating Company* Appoint directors and exercise reserve powers Hospital A1** Hospital A2 Hospital B1 Hospital B2 * JOC board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** Each hospital retains its license, governing board, and assets 26

27 Why do they care about control? A JOA often doesn't have this type of structural control Thus, the IRS examines four factors to determine whether JOC has equivalent of parent-subsidiary relationship with the participating hospitals 27

28 Joint Operating Company Parents Retain Board Selection Parent A Appoint hospital directors Reserve powers over hospital organic changes Appoint JOC directors Reserve powers over JOC organic changes Joint Operating Company* exercise Parent B Appoint hospital directors Reserve powers over hospital organic changes reserve powers Hospital A1** Hospital A2 Hospital B1 Hospital B2 * JOC board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** Each hospital retains its license, governing board, and assets 28

29 IRS Factor 1: Delegation of Significant Authority over Participating Entities JOC should have power to, e.g.; - Establish budgets - Establish strategic plans - Approve debt - Reallocate income among entities (financial integration) 29

30 IRS Factor 2: Permanence A temporary relationship doesn't look like a parentsubsidiary relationship Is there glue to hold the parties together through disputes - E.g., arbitration or other dispute resolution Are there disincentives to voluntary termination - E.g., penalties for walking 30

31 IRS Factor 3: Veto Rights JOC exercises control, not just veto, over participants - Can initiate action, not just react JOC members have limited ability to veto JOC decisions 31

32 IRS Factor 4: Limited Reserved Powers Members have limited powers over JOC Only shareholder-type powers Member powers over JOC aren't exercised indirectly though class voting on JOC board 32

33 Joint Operating Company Parents Retain Board Selection Parent A Appoint hospital directors Reserve powers over hospital organic changes Appoint JOC directors Reserve powers over JOC organic changes Joint Operating Company* exercise Parent B Appoint hospital directors Reserve powers over hospital organic changes reserve powers Hospital A1** Hospital A2 Hospital B1 Hospital B2 * JOC board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** Each hospital retains its license, governing board, and assets 33

34 Partial System JOAs Affiliates not participating in JOA aren't integrated Services to them may be UBI 34

35 Joint Operating Company Partial Hospital System Participation Parent A Parent B Appoint JOC directors Reserve powers over JOC organic changes Exercise all Parent powers Appoint hospital directors Reserve powers over hospital organic changes Joint Operating Company* exercise Appoint hospital directors Reserve powers over hospital organic changes reserve powers Hospital A1** Hospital A2*** Hospital B1*** Hospital B2 * JOC board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** May be unincorporated division of Parent *** Each hospital retains its license, governing board, and assets 35

36 36 Antitrust Issues

37 Antitrust Issues Dovetail with Tax Exemption Issues In each case, the test is whether the parties have created a unity of economic interest through the JOA 37

38 Reason for Antitrust Concern If JOA members are competitors, their joint planning and pricing through the JOA is anti-competitive Sherman Act Section 1 prohibits contracts, combinations and conspiracies between two or more parties that unreasonably restrain trade - Such as price fixing - Such as market allocation Note that unity of economic interest doesn't help with Sherman Act Section 2 monopolization issues 38

39 What is Unity of Economic Interest? Copperweld Corp. v. Independence Tube - Wholly owned subsidiaries can't conspire with parent As with tax exemption, the objective is to make the JOC akin to a parent and the hospitals in the JOA akin to subsidiaries 39

40 What is Unity of Economic Interest? Control over appointment and removal of directors and officers Control over hospitals' corporate documents Ability to operate and control the hospitals' assets and clinical programs subject to typical shareholder powers JOC control over JOA budget and strategic plan and those of hospitals Limited rights of members or hospitals to terminate, and it's hard to to do so - FTC/DOJ guidelines suggest 10 years JOC can allocate profits and losses, assess capital contributions, and negotiate managed care contracts 40

41 Partial System JOAs As in tax exemption, the system parts not controlled by the JOC remain competitors of the JOC 41

42 Potential Pitfalls of JOAs Tension between super parent and active hospital subsidiaries May be dissonance between the mission of the super parent and the mission of a member hospital corporation or between the member hospital corporations that is played out at super parent level Hospital may be generating revenue that is directed to other entities in the system More complex from a regulatory standpoint to manage because discrete entities remain in place 42

43 Anatomy of Failed JOA Some have been unwound because of tension between the hospital corporations and the new parent In 2008 Health Alliance in Cincinnati was sued to permit two hospitals to exit the JOA Ultimately state court of appeals permitted the hospitals to terminate their relationship with the JOA because Health Alliance was determined to have defaulted on the JOA 43

44 Anatomy of Failed JOA Health Alliance was formed in 1995 by a JOA and ultimately included four hospitals: Christ Hospital, Saint Luke s Hospitals, Jewish Health Systems and Fort Hamilton Certain powers were reserved to hospital corporations: ownership of plant, property, equipment and ultimate responsibility for fulfilling respective charitable missions (Health Alliance of Greater Cincinnati v. Christ Hosp., 2008 Ohio-4981) 44

45 Anatomy of Failed JOA Christ Hospital accounted for some 40% of the revenues of the Alliance but very few funds were directed to Christ Hospital Trustees of Christ Hospital feared that the Alliance planned to close their Auburn Hospital Christ Hospital would take on new debt through tax exempt bond financing that would not generate funds for its use Provided termination notice based on breach of the Joint Operating Agreement 45

46 Anatomy of Failed JOA Health Alliance dispute also points to potential tension arising from exercise of fiduciary duty in system with significant governance powers still residing at local corporate level Ohio appellate court noted that the Christ Hospital directors were exercising their fiduciary duties in attempting to preserve assets Court also ruled that Alliance had a fiduciary responsibility to the member hospitals 46

47 BUT JOAs Work and Have a Future Saint Joseph/Candler hospitals in Georgia are still operating under a JOA since 1995 Several new JOAs have been formed in the last few years Poudre Valley Health System/University of Colorado Hospital KentuckyOne and University of Louisville Hospital Saint Joseph s Hospital and Emory Healthcare 47

48 Other Legal Issues in Formation of Joint Operating Agreement Antikickback (AKS): Broad federal statute that prohibits offering or soliciting anything of value in return for referrals (42 U.S.C. 1320a-7b(b)) Stark: prohibits physicians from referring patients for the designated health services from entities with which the physician has a financial relationship unless an exception applies (42 U.S.C. 1395nn) 48

49 JOAs and AKS and Stark JOAs typically do not include physician groups as owners so does not usually raise new Stark issues that would not have been resolved at the direct financial relationship level Although JOA may create a new link for Stark purposes, should not create new indirect relationship if physicians are not compensated on the value or volume of referrals to the entity billing/providing DHS 49

50 Stark and Antikickback AKS issues may be implicated because JOAs involve financial relationships among referral sources that remain discrete entities Need to examine each arrangement among participating entities to ensure that funds flow mechanisms do not act as an impermissible inducement for referrals e.g., physician groups affiliated with one hospital member entering into an arrangement with another hospital member OIG provided safe harbor for Cooperative Hospital Service Organizations payments to these from the member hospitals for service provided by CHSO thought to implicate AKS (42 CFR (q)) 50

51 JOAs Strategic/Practical Considerations Clearly identify strategic goals to be achieved by a partnership Need to fill in service gaps on a continuum? Need strong financial partner? Need stronger management capability? What is the appropriate model to meet the strategic goals? Strongly centralized governance versus local control High level of system integration versus divergence in management or clinical services 51

52 JOAs Strategic/Practical Considerations Any limitations to merger to be considered? Religious mission? Public Status? Community political factors? 52