Healthcare Facilities in Bankruptcy

Mid-South Commercial Law InstituteDecember 6, 2013

Page 2

Paul G. JenningsBass, Berry & Sims, PLLC

Michael R. HillHarwell Howard Hyne Gabbert & Manner

W. James LloydPershing Yoakley & Associates, P.C.

Panel

Page 3

Paul G. Jennings Paul G. Jennings serves as the chair of Bass, Berry & Sims PLC’s Bankruptcy and Restructuring Practice. Paul

has over 23 years of experience in bankruptcy, insolvency and distressed asset matters, including representing

large corporate debtors, unsecured creditor committees, case trustees and plan trustees. Over the course of his

practice, Paul has represented a number of purchasers of distressed assets, both in and out of bankruptcy

proceedings, in several different industries. Paul has significant litigation experience in bankruptcy and insolvency

related matters, including preference, fraudulent conveyance and board fiduciary duty matters.

A significant portion of Paul’s work over the years has been in the healthcare industry, including restructurings and

representing purchasers of healthcare businesses and facilities.

Paul is a member of the American Bankruptcy Institute, the Nashville Bar Association and the Tennessee Bar

Association, where he was past president for the Section of Commercial, Bankruptcy and Banking Law. In 2005, he

was named to the National Register's Who's Who in Executives and Professionals. Paul is listed in Best Lawyers,®

has been named one of the best bankruptcy lawyers by Business Tennessee magazine since 2004 and one of

Tennessee's leading bankruptcy litigation lawyers by Chambers USA. For the past four years, he has been listed in

the Nashville Business Journal's Best of the Bar, a distinction earned exclusively by nominations from other

attorneys. In 2006, Paul was listed in the Lawdragon 500 New Stars, New Worlds. In 2014, he was named Best

Lawyers® 2014 Nashville Bankruptcy and Creditor Debtor Rights/Insolvency and Reorganization Law Lawyer of the

Year.

Page 4

Michael R. Hill Mike Hill is leader of h3gm’s Healthcare Practice Group. He focuses on business law matters primarily involving

healthcare companies from start up to maturity and advises them on corporate, transactional and operational issues.  In his transactional practice, Mike advises his clients on compliance with the broad range of regulation applicable to the healthcare field.  He also regularly represents individual physicians and group practices on matters such as group formation and compensation formulas, joint ventures, employment agreements, recruiting agreements, and professional services arrangements. 

He was a member of the inaugural class of the Nashville Health Care Council’s Fellows Program, serves on the board for the Nashville Health Care Council and has been featured by Chambers USA: America’s Leading Lawyers for Business, Nashville Medical news and the Nashville Business Journal as a leader in healthcare law.

Page 5

W. James Lloyd, CPA/ABV, ASA, CFE W. James (Jim) Lloyd is a Principal in the valuation and dispute services practice of Pershing Yoakley &

Associates, P.C. Jim has over 25 years of experience providing valuation, economic damages, and other consulting services to a multitude of organizations across the U.S. Significant healthcare experience includes: Ambulatory Surgery Centers, Cancer Centers, Dialysis Centers, Hospitals, Imaging Centers, Pharmacies, Pharmaceutical Manufacturers, Physician Practices, and Retirement/Assisted Living Facilities, among others.

Jim is a frequent speaker at various national conferences and has authored/co-authored multiple articles on valuation and dispute-related topics. Mr. Lloyd is the past Chair of the American Institute of CPA’s Accredited in Business Valuation Credential Committee, and past member of the American Society of Appraisers’ Board of Examiners. Jim has substantial expert testimony experience in federal and various state and local courts and arbitration proceedings across the U.S.

Professional credentials include: Certified Public Accountant (CPA), Accredited Senior Appraiser (ASA), Accredited in Business Valuation (ABV), and Certified Fraud Examiner (CFE).

Page 6

Overview of Healthcare Facilities and Key Issues Healthcare Regulatory Environment Valuation of Healthcare Facilities Red Flags for Healthcare Businesses in Bankruptcy

or Distress

Presentation Overview

Page 7

Healthcare Regulatory Environment and Key

Definitions

Page 8

Road100m

Menu

STARK LAW

Prohibited self-referrals for Medicare and Medicaid patients.

Navigating the Regulatory Environment

ANTI-KICKBACK STATUTEKnowingly and willful offers, payments, or receipts for referrals.

IRS-NFP REQUIREMENTS

IRC Section 501(c) 3 requirements

Page 9

Commercial Reasonableness Department of Health and Human Services Definition1

◦ An arrangement which appears to be “a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.”

Stark Definition2

◦ “An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential designated health services (“DHS”) referrals.”

OIG Threshold 3

◦ Compensation arrangements with physicians should be “reasonable and necessary.”

1 63 Fed. Reg. 1700 (Jan. 9, 1998).2 69 Fed. Reg. 16093 (March 26, 2004).3“OIG Compliance Program For Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).

Page 10

IRS Definition1

◦ Fair market value (“FMV”) is defined as the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and both have reasonable knowledge of the relevant facts.

OIG/Stark Definition2

◦ The value in arm’s-length transactions, consistent with the general market value

◦ The price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement.

Fair Market Value

1Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237.2Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.

Page 11

Fair Market Value – Key Concepts Determined from the perspective of hypothetical buyers

and sellers without the ability to refer business to one another.

No consideration for post-transaction buyer synergies. However, such synergies often exist!

The financial terms of the transaction must make economic sense based on the assets being sold/received.

Post-transaction compensation must be taken into consideration.

Page 12

Federal statute

◦Section 1128B of the Social Security Act is an intent-based statute that prohibits the knowing and willful offering, paying, soliciting or receiving of any remuneration to induce or to reward referrals of items or services payable by federal health care programs, including Medicare and Medicaid. [42 U.S.C. § 1320a-7b(b)]

Anti-Kickback Statute

Page 13

◦ Section 1128B of the Social Security Act prohibits the offering, paying, soliciting or receiving of any remuneration to induce or to reward referrals of items or services payable by federal health care programs, including Medicare and Medicaid. [42 U.S.C. §1320a-7b(b)]

◦ Covers referrals for any item or service that might be paid for by Medicare or any other federal healthcare program

◦ Provides for criminal liability to both sides of an illegal transaction, even where only one purpose of the remuneration offered, paid, received, etc., is to obtain money in exchange for referrals or to induce referrals

Anti-Kickback Statute – Cont’d

Page 14

Section 6402(f) of the Patient Protection and Affordable Care Act (“PPACA”) added the following two sub-sections to the Anti-Kickback statute:

◦ Claims for items and services provided to federal health care program beneficiaries that violate the Anti-Kickback statute constitute false or fraudulent claims for purposes of the Civil False Claims Act [42 U.S.C. §1320(a)-7b(g)]

◦ A person does not need actual knowledge of the Anti-Kickback statute or specific intent to violate the Anti-Kickback statute [42 U.S.C. §1320(a)-7b(h)]

Anti-Kickback Statute – Cont’d

Page 15

[42 CFR §1001.952]◦ Investment interests

◦ Space rental

◦ Equipment rental

◦ Personal service and management contracts

◦ Sale of a practice

◦ Employees

◦ Practitioner recruitment

◦ Obstetrical malpractice insurance subsidies

◦ Investments in group practices

◦ Ambulatory surgical centers

Anti-Kickback Safe Harbors

Page 16

First Published October 30, 1998 (63 Fed. Reg. 58399).

Provides guidance on how to conduct investigation, quantify damages and report.

235 cases resolved between 2008 and April 2013.

Conduct at issue must constitute a potential violation of law, not merely on error or overpayment.

Primary benefit for providers is a reduction in the damages multiplier (1.5x instead of 3x).

OIG may consider a provider’s ability to pay.

OIG: Provider Self-Disclosure Protocol

Page 17

The federal physician self-referral prohibition (“Stark Law”) prohibits a physician from referring Medicare patients for designated health services (“DHS”) to an entity with which the physician, or the physician’s immediate family member, has a financial relationship, unless the relationship meets the specific requirements of a Stark exception. [42 U.S.C. §1395nn]

Prohibits the entity from submitting a claim (or causing a claim to be submitted) to Medicare

“Financial relationships” include both ownership and compensation relationships.

◦ Strict liability statute – no intent to violate necessary.

Stark Law

Page 18

[42 CFR §411.355]◦ Clinical laboratory services

◦ Physical therapy, occupational therapy, and outpatient speech-language pathology services

◦ Radiology and certain other imaging services

◦ Radiation therapy services and supplies

◦ Durable medical equipment and supplies

◦ Parenteral and enteral nutrients, equipment, and supplies

◦ Prosthetics, orthotics, and prosthetic devices, and supplies

◦ Home health services

◦ Outpatient prescription drugs

◦ Inpatient and outpatient hospital services

Designated Health Service (DHS)

Page 19

◦ General exceptions to both ownership and compensation: [42 CFR §411.355]

Physician services

In-office ancillary services

Academic medical centers

◦ Exceptions related to ownership or investment interests: [42 CFR §§ 411.352 and 411.356]

Physician-owned hospitals

ACA prohibitions

Grandfathered hospitals and expansion prohibitions

Stark Law Exceptions

Page 20

◦ Exceptions related to compensation arrangements:[42 CFR §411.357] Rental of office space Rental of equipment Bona fide employment Personal service arrangements Physician recruitment Isolated transactions Fair market value compensation Indirect compensation arrangements Obstetrical malpractice insurance subsidies Retention payments in underserved areas

Stark Exceptions – Cont’d

Page 21

Under prior Self Disclosure Protocol, provider had to indicate that fraud was involved.

Established under § 6409 of ACA.

Full investigation and report required.

Potential for significantly reduced damages.

Significant backlog of applicants. As of March 2013, CMS had received over 250 disclosures, and settled only 19.

Self-Referral (Stark) Self Disclosure Protocol

Page 22

◦ CON laws limit expansion of healthcare facilities and serve as barrier to market competition.

◦ Some state laws provide exemptions for relocations, capital expenditures subject to threshold, change of ownership, and acquisitions

◦ Because of restrictions on establishing certain types of healthcare facilities or offering of certain types of healthcare services, CON laws may have significant value [See 50 State Survey of Certificate of Need and Licensure: Nursing Homes, Assisted Living, Home Health, and Hospice, American Health Lawyers Association (2009)]

Certificate of Need Laws (“CON”)

Page 23

CON / State Licensure Requirement◦ Varies by state.

◦ May impact timing of closing. Many state licensing agencies require 30-60 day pre-closing notification requirements. In some states, CON approval may take several months.

◦ Not limited to main business line (i.e., hospitals have myriad licenses for various functions, departments and pieces of equipment).

◦ May vary by nature of transaction (stock sale v. asset sale).

Medicaid◦ Varies by state.

◦ May include successor liability.

Medicare◦ Consistent application regardless of state.

◦ Only applies to a sale of assets. Sale of equity results in a “Change of Information” filing.

◦ Part A Providers and Part B Suppliers treated differently.

◦ Potential for significant interruption in cash flow.

◦ ”Provider Number” issues.

Change of Ownership (“CHOW”)

Page 24

◦ State Anti-Kickback laws: Applicability to state Medicaid services Limitations of violations, duty to report, specific

behavior Availability of safe harbor protection

◦ State Stark Laws: Applicable to specific payer or unlimited by payer

type Applicable to broad “practitioner”

◦ State corporate practice of medicine laws◦ State non-profit and charity laws

State Laws

Page 25

Valuation of Healthcare Facilities

Page 26

Valuation Approaches There are three general approaches for valuing any

business/asset, which are:

◦ Asset (“cost”) Approach

◦ Income Approach

◦ Market Approach

Page 27

Asset Approach Based on the anticipated cost to replace, replicate, or

recreate the asset.

Generally used for non-operating type entities and/or businesses that generate no/nominal cash flow.

Net Asset Value Method.

Page 28

Net Asset Value (“NAV”) Method

Assets and liabilities are adjusted to their respective current values, and then the liabilities are subtracted. Result = the entity’s net equity (i.e. “net asset”) value.

Often requires third-party appraisals of the tangible assets.

Commonly used for businesses that lack positive cash flow (e.g., physician practices with no excess cash flow after subtracting the physicians’ fair market value compensation.

Page 29

Income Approach Based on the entity’s earning power (i.e., ability to

generate income/cash flow for the owners).

Generally most applicable for operating entities with positive earnings and growth prospects.

Primary methods include:

◦ Discounted Cash Flow Method

◦ Capitalized Income Method

Page 30

Discounted Cash Flow (“DCF”) Method Provides an indication of value based on the entity’s ability to

generate positive net cash flow.

◦ Net cash flow = the excess above all necessary operating costs, working capital requirements, and capital expenditures.

◦ Amount available for distribution to the owner(s).

Cash flows must be projected for a discrete period of time and then discounted to present value utilizing a risk adjusted discount rate.

Terminal period cash flows are capitalized.

Page 31

Capitalized Income Method Uses a single period measure of net cash flow as a proxy

for future periods.

Value determined by capitalizing the single period cash flow stream with a capitalization rate.

◦ Capitalization rate = Discount rate – long term growth rate

◦ Assumes future cash flows will grow at the long-term growth rate

Primarily used for mature/low growth businesses.

Often difficult to use for healthcare entities.

Page 32

Market Approach Based on market transaction data involving similar

businesses/assets.

Often difficult to use for small/medium sized healthcare entities due to substantial differences across markets and other factors.

Primary methods include:

◦ Guideline Public Company (“GPC”) Method

◦ Merger and Acquisition Transaction (“M&A”) Method

Page 33

Guideline Public Company Method Utilizes valuation multiples developed from publicly traded

guideline companies.

Guideline companies must be “sufficiently similar” to the subject entity but not necessarily the same.

Common multiples include: price/earnings (P/E), price/sales, price/beds, price/book value, etc.

Generally difficult to use for most small/medium sized businesses.

Page 34

Merger & Acquisition Transaction Method

Utilizes valuation multiples developed from similar entities that have been bought/sold.

Requires reliable transaction data involving similar businesses.

Valuation multiples must be closely correlated to the transaction price.

Irving Levin & Associates – good resource for healthcare transaction data.

Page 35

Which Method(s) are Most Appropriate?

…has positive

cash flow, the

Income and

market

approaches will

probably be

appropriate.

…does not

have positive

cash flow, the

NAV method

will probably be

necessary.

IT DEPENDS…

If the business…

Page 36

Reconciling the Value Indications As a general rule, all applicable valuation methods

should be utilized and the various indications of value reconciled (i.e. weighted) for purposes of determining the entity’s value.

Weightings should depend upon the facts and circumstances and reliability of the underlying data/assumptions.

Page 37

Red Flags for Healthcare Businesses in Bankruptcy or

Distress

Page 38

Red Flags for Healthcare Businesses in Bankruptcy or Distress

Excessive compensation/distributions

Excessive debt/leverage

Insufficient cash/working capital

Operating metrics substantially different than peer group

Outdated facilities/equipment/technology

Declining physician base

Page 39

Physician Compensation

◦ Should make sense relative to professional productivity (e.g. collections, wRVUs)

◦ Multiple benchmark sources readily available (e.g. MGMA)

Executive Compensation

◦ Should be FMV for tax-exempt entities

◦ Multiple benchmark resources available

Excessive Compensation/Distributions

Page 40

Balance Sheet Analysis Accounts Receivable

◦ Generally omitted from most physician practices and other small healthcare businesses (cash basis of accounting).

◦ Gross vs. net of contractual adjustments?

◦ Collectability.

Medical Supplies

◦ Generally expensed when purchased.

◦ Inventory or estimate based on purchase activity.

Page 41

Balance Sheet Analysis Fixed Assets

◦ Often have very little “book value” and/or resale value. However, they will generally have “in-use” value as long as still being utilized.

◦ Often requires third party appraisal for large ticket items.◦ Key issues:

Do the assets actually exist? Are they still being used? Condition of the equipment – upgrades and service

agreements

Page 42

Balance Sheet Analysis Accounts Payable/Accrued Expenses

◦ Often excluded from the balance sheet.

◦ Can generally be identified through inquiries, analysis of operating expenses, and subsequent payments.

◦ Prior year retirement plan contribution liability.

Other (Unrecorded) Obligations

◦ Future lease payments (equipment and/or facilities).

◦ Equipment service agreements.

Page 43

Balance Sheet Analysis Debt obligations

◦ Third party loans – terms, security, purpose.

◦ Related party loans – debt vs. equity.

◦ Lease agreements.

Equipment

Facilities

FMV lease rates?

Page 44

Analyzing Revenue Net revenue by type of service (service mix)

◦ Evaluate on per CPT code, encounters, etc. basis.

◦ Volume and reimbursement trends .

◦ Benchmark to Medicare fee schedule for reasonableness.

Net revenue by physician/provider

◦ Assess risk.

◦ Evaluate FMV compensation.

Page 45

Payer mix

◦ Net revenue per procedure should make sense relative to the Practice’s payer mix.

Bell curve analysis

◦ To help identify “up coding” and similar compliance type problems.

Revenue Analysis – Cont’d

Page 46

Operating expenses can generally be easily benchmarked for reasonableness (e.g. MGMA Cost Survey, etc.).

Trending and ratio analysis to help identify unusual transactions and possibly non-recurring expenses.

Not unusual to find some “personal” expenses in most physician practices and other small/closely-held healthcare businesses

Operating Expenses

Page 47

Trending and ratio analysis to help identify unusual transactions and possibly non-recurring expenses.

Not unusual to find some “personal” expenses in most physician practices and other small/closely-held healthcare businesses

Financial Distress

Page 48

Governance

◦ Active and Engaged Board

◦ Recognizing distress early and moving to address

◦ Consider need for outside expertise, replacement management or CRO

◦ Directors & Officers Insurance Coverage and Indemnity

Communication

◦ Employees/medical staff

◦ Secured lenders

◦ Suppliers/vendors

◦ Payors

◦ Community/elected officials

Financial Distress Considerations

Page 49

Restructuring Options

◦ Chapter 11 Reorganization

◦ Chapter 11 Liquidation

◦ Chapter 7/Closure

Financial Distress Considerations

Page 50

Sale Transactions◦ Government consent to transfer of provider number and

inability to cut off recoupment (i.e. overpayments, etc.) Financing Healthcare Receivables

◦ Medicare/Medicaid A/R may not be collected directly by a lender

Disposal of patient records Provider agreement – recoupment On-going fraud and abuse investigations may not be

stayed

Healthcare Bankruptcy - Unique Challenges

Page 51

Exclusion from Medicare or other governmental programs Expanded Administrative Expense Priority Claims

◦ For actual and necessary costs and expenses of closing – healthcare business and with regard to disposal of patients’ records or transfer of patients

Patient Care Ombudsman◦ 2-part test for appointment of ombudsman

(i) Whether debtor is a healthcare business (ii) Whether totality of circumstances warrants the appointment of

an ombudsman

◦ Duty is to monitor the quality of patient care and to represent the interests of patients

Healthcare Bankruptcy - Unique Challenges

Page 52

Questions?

Page 53

Contact InformationW. James Lloyd, CPA/ABV, ASA, CFE

Principal | Pershing Yoakley & Associatesjlloyd@pyapc.com | (865) 673-0844

Paul G. Jennings, Esq.Member | Bass, Berry & Sims, PLLC

pjennings@bassberry.com | (615) 742-6267

Michael R. Hill, Esq.Shareholder | h3gm

Mike.hill@h3gm.com | (615) 251-1046