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While other joint ventures are waning, joint-ventured ASC transactions between physicians and hospitals appear to be on the rise. Access to favorable contracts, capital needs and politics are driving doctors and hospitals — otherwise would-be competitors — to partner in the development and ownership of surgical centers. However, these transactions can present challenges, including the hospital partner's need for majority ownership and governance control, along with significant reservations of power to the hospital partner (the ability to approve or block action on a given matter, for example) to preserve the hospital's tax-exempt status.
This article reviews certain critical legal and business issues that make structuring joint ventures a challenge. Like any healthcare venture, an ASC partnership between a hospital and a group of physicians can be difficult to manage. Fortunately, you can overcome most of these challenges so long as the parties remain flexible and willing to compromise. Here are 6 key issues to monitor:
1. Control over development. The development phase of any venture is critical, and missteps can have long-lasting effects. It's not uncommon to see ASC ventures lack structure and meander during development, costing the partners money and time. In addition, ASCs can be overbuilt due to unrealistic volume projections or a desire to construct a monument to the owners. You generally can avoid these problems by engaging a professional, third-party developer at the outset of a project. Organizations that specialize in ASC development are often best suited to help the venture parties conceive the design of a facility, recruit any additional physician-partners, develop accurate volume and financial projections, contract for the construction and equipping of the building, staff the ASC, and assist in licensure and certification. Certain developers may offer development services on a standalone basis (often for a flat fee), while others also may seek long-term management contracts (discussed later) and equity stakes in the venture.
2. Equity and voting control. The allocation of equity and voting control can be a point of contention between the parties. Physicians are usually initially hesitant to cede control of the ASC to the hospital. That said, there are certain compelling reasons to grant equity and voting control of the venture to the hospital. For example, as noted above, access to the hospital's managed care contracts is often a reason, if not the reason, for a joint-ventured ASC. In order to gain such access, however, many payors require that the hospital partner hold the majority of the equity in the ASC (generally, more than 50%). Without this level of equity integration, it's becoming increasingly unlikely that ASCs will be able to participate in hospitals' contracts (and receive their favorable rates).
3. Antitrust laws. In addition to the above, several legal issues could drive equity and voting control to the hospital, not the least of which is the effect of state and federal antitrust laws. Generally speaking, antitrust laws make illegal any contract, combination or conspiracy among 2 or more independent economic actors to, among other things, fix prices or engage in boycotts. In most ASC transactions, the hospital partner is likely to maintain surgical services that will compete with those of the ASC. If the ASC and the hospital partner intend to jointly negotiate managed care contracts, the antitrust laws will generally require the ASC and the hospital to "integrate," meaning at minimum the hospital must have voting control over certain critical financial decisions. If structured incorrectly, a physician-hospital ASC joint venture may be seen as an illegal conspiracy. In order to avoid such claims, it's generally necessary that the ASC joint venture essentially function as a "subsidiary" of the hospital partner.
4. Tax-exempt status. Antitrust issues aside, many hospitals are tax-exempt organizations and can be zealous in the protection of their tax exempt status. The Internal Revenue Service has long taken the position that joint ventures between hospitals and physicians are "suspect" and, as such, hospitals require a certain amount of protection of exempt assets when partnering with physicians. This often means that a tax-exempt hospital partner will seek to maintain equity and voting control or, short of that, require that it have certain "reserved powers" that will let the hospital override any decisions (whether made by the board or the owners) that might otherwise jeopardize the hospital's exempt status.
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Why Are ASC Joint Ventures Increasingly Popular Today? |
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An ambulatory surgery center is a business, and a business runs on cash. Steady and sufficient cash flow is critical to the operation of an ASC. Achieving this cash flow requires strong managed care and commercial contracts — contracts not always available to small, standalone facilities. The past decade has seen a great deal of contracting leverage come to rest in the hands of a small number of payors. Moreover, Medicare cuts have made private contracts much more important. Participation in broad networks — now the province of large providers — is essential to most providers. For this reason alone, physician-owners of ASCs are coming around to the idea that a hospital partner with access to rich contracts is critical to the ASC's long-term survival. Most payors will treat an ASC as an "affiliate" of a hospital — thus allowing the ASC to benefit from the hospital's reimbursement rates — so long as the hospital holds at least a majority of the ASC's equity. ASCs can be capital intensive. Without a hospital partner to meet ongoing capital needs, the physician-owners of an ASC are often required to guarantee debt or meet capital calls, which in these financial times can be difficult. Until recently, hospitals have had easy access to significant amounts of capital, which has made them attractive to physicians who find themselves bereft of cash. Political pressure is another driver of these unions. In states where a certificate of need is required to establish an ASC, hospital partners are often critical to securing such approval. Hospitals can have significant influence on the decision to approve a CON, either by actively helping to justify the CON or by withholding objection to its issuance. Further, many hospital providers have long and successful track records with the planning boards that approve certificates of need and, as such, can add credibility to an ASC project simply by being involved. Then there is simply the concept of "keeping the peace." Physicians are sometimes hesitant to go into direct competition with the local hospital. This hesitancy is sometimes based on the concern that competition will invite reprisals by the hospital, such as the redirecting of referrals, the hiring of competing physicians or the revocation of privileges at the hospital. These fears are sometimes real and sometimes perceived but are, nonetheless, a driver. — Roger Strode and Linas Grikis |
The levels of control discussed above are not absolutes. Each situation should be independently considered; quite often, there is a great deal of negotiation between the physicians and the hospital over control. Regardless of the level of control held by the hospital, it is common, and makes good business sense, to let physician partners control many of the medico-administrative and clinical decisions made during the development and operational phases of the venture. These decisions often include clinical staffing (including hiring and firing), equipment selection, quality and utilization review and capital prioritization related to clinical issues.
5. Management control. Quite often the decision by a group of physicians to develop, own and operate an ASC is due to a lack of satisfaction with scheduling, room turnover, staffing and, in general, management of the local hospital's operating rooms. For these reasons, physicians are generally unwilling to let the hospital manage the ASC. On the other hand, hospital leadership feels quite capable of managing facilities such as an ASC. Moreover, certain hospitals contend that management of the ASC is consistent with, and otherwise protects, the hospital's exempt status.
Similar to resolving development issues, management issues can often be solved by engaging a third-party manager. An independent manager can provide day-to-day management support, freeing the hospital and physician-owners to focus on patient care. There are scores of independent management companies capable of managing ASCs. These organizations handle all aspects of management, including scheduling, human resources administration, budgeting and accounting, all subject to the review and approval of the facility's governing board. Management fees are typically based upon a percentage of revenues or collections, which generally range from 3% to 7% of net revenues. Some fee structures include minimum fees or additional fees for staffing or billing services.
6. Exit strategies. The possibility that the venture will need to be unwound raises a number of potential issues that you must consider during negotiations. For example, simply determining the events that can cause a dissolution, and the procedure for effecting a dissolution, can take considerable time and discussion. Also, the parties will need to discuss and determine the events that automatically cause redemption of a partner's ownership interest. In addition to these difficult discussions, the parties must also consider how the proceeds and assets will be distributed in the event of a redemption or dissolution.
Hospital partners will often require that the terms of the venture be revisited, or if the situation is dire enough, that the deal be unwound, in the event that changes in law (or its interpretation) cause one or more elements of the deal to be deemed illegal or to jeopardize the hospital's exempt status. While these requirements sound fine in theory, putting these concepts into practice can be challenging. For example, the concept of "illegality" can be difficult to quantify. Another issue that can arise is that of what constitutes "jeopardy" to the hospital's exempt status. These concepts, and more, have to be vetted by the parties — along with concepts of materiality — as they can have lasting and far-reaching implications to the transaction.
In addition, the parties must consider what it means if the venture is unwound. For example, if a party has to exit the transaction, does that mean the entire venture needs to be liquidated and dissolved? Moreover, the parties may need to consider the effect of state law "change of ownership" rules, for in certain instances the sale of 50% or more of the ownership interests in a facility may impact licensure or, worse, certificates of need. Moreover, if a CON is involved, which party will be entitled to keep it? These and many more issues must be considered in the event that either party is required to exit the deal.
Say yes to success
The old saying goes that you don't engage in a joint venture because you want to, you do it because you have to. But for many reasons, physician-owners of ASCs are discovering that partnering with a hospital not only brings certain advantages, but may be critical to the venture's long-term success. Although you'll need to work through myriad legal and business issues, if the parties are flexible and trust that the other is committed to the overall success of the venture, they are likely to find that this unlikely marriage can be successful.
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