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Permissible physician-hospital joint ventures

By Daniel M. Bernick, Esq., MBA

In the past year, physicians and hospitals have begun considering an increased number of options for joint venturing various ancillary services. These services include ambulatory surgery centers, diagnostic services, equipment leasing ventures, real estate investments and other opportunities. These joint ventures present physicians with attractive opportunities to supplement their medical practice income and thereby offset the negative financial impact of rising overhead costs and stagnating professional fee income. However, all such joint ventures need to be approached with caution and appropriate legal due diligence, as they nearly always raise issues in terms of compliance with the federal antikickback/fraud and abuse rules, the Stark law, state anti-referral or “mini Stark” laws, and other rules.

The current interest in joint ventures has been prompted by a number of factors. First, new regulations issued last spring clarified the scope and terms of the Stark law. The new rules eliminated ambiguity with respect to a number of aspects of Stark, and thereby provided physician and hospital legal counsel with more assurance that a well thought out arrangement would in fact survive scrutiny by the government.

Another factor is that in many cases, the cost of medical technology has dropped far enough so that physicians are willing to consider making the financial investment necessary to get into the business of providing ancillary services. For instance, nuclear cameras for cardiology can be acquired for only $200,000 to $300,000, which is financially within reach for a group of five or six physicians.

Hospitals, for their part, are concerned that they are going to lose these ancillary revenues to newly formed, competitive physician ventures. Better to joint venture with the doctors, then, and keep part of these revenues, than do nothing and potentially lose all of these revenues. Hospitals are also further disposed to consider or propose a joint venture with physicians in that it enables the hospital to lay off a portion of their heavy capital budgets on the physicians, who will as part of the venture pony up a substantial part of the investment funds needed to acquire the new equipment, building, or other capital cost.

While attractive from a business perspective, all such joint ventures need to be approached with appropriate legal due diligence. The Department of Health and Human Services Office of Inspector General (OIG) is very much aware of the renewed interest in joint ventures, and has issued several pronouncements indicating substantial suspicion, from a compliance perspective, with certain “contractual joint ventures” that (allegedly) lack any legitimate business purpose, other than rewarding physician referrals. Physicians should therefore attain a good level of confidence in the legality of any venture that they undertake, so that they are ready to defend against any legal challenge.

The first step in the legal analysis is generally a Stark review. In contrast to the federal antikickback rules, where “gray areas” abound and legality is often an attorney judgement call, the Stark law provides numerous “bright line” tests for compliance. Therefore, if a proposed venture fails to pass muster under Stark, no further time or money need be expended reviewing antikickback or other laws: the arrangement will need to be restructured or perhaps discarded.

In this regard, there are some services that are more conducive to a legal joint venture arrangement, because they are not subject to Stark at all. For example, a freestanding ambulatory surgery center owned 50 percent by physicians and 50 percent by a hospital system would be exempt from Stark issues. Other services not subject to Stark include nuclear medicine, PET (without CT), lithotripsy, cath labs and sleep labs.

These ventures must still be examined for compliance with other laws, such as antikickback rules, IRS private inurement/private benefit rules (when the hospital is a tax-exempt, charitable institution), state self-referral/”mini Stark” laws, and even antitrust laws (when the hospital owns a portion of an ASC, and helps negotiate reimbursements for the ASC), but not having to comply with Stark gives such ventures a huge advantage, in terms of ease of legal compliance.

Note that the above services are only exempt from Stark if located off the hospital’s premises. If rendered on the hospital’s premises, the service will likely become an “inpatient or outpatient hospital service” and thereby again become subject to the Stark rules. It may still be possible to comply with Stark in this situation, but there will be more legal obstacles to overcome.

Another way that physicians and hospitals can co-venture is with respect to joint ownership of equipment or real estate that is leased either to the hospital or to a separate physician venture. For instance, a hospital seeking funds for a new medical office building could give up a substantial portion of equity in the venture in return for capital funds from the physicians. So long as the rental rate is priced at fair market value and meets other important legal requirements (lease in writing, for at least one year, payments fixed in advance), the venture can be expected to withstand legal challenge. The physicians gain access to an investment providing them with a respectable return (and potential future appreciation!), and the hospital achieves closer ties with its physicians, plus a reduced capital budget.

The joint ventured office building is an example of a typical hospital-driven project, where the hospital reduces its capital budget by involving physicians. However, the venture could just as easily be physician-driven, such as with an ambulatory service center that the physicians are unwilling to finance by themselves. Involving the hospital as an investor enables the physicians to achieve the desired goal of building an ASC without having to bear the full cost of the venture by themselves. The hospital may also be a desirable partner in this context due to its superior access to capital markets and its “clout” in negotiating facility payment rates with commercial insurers.

The examples above all contemplate joint ownership in the venture by hospital and physicians. However, that is not only way of bringing hospitals and physicians together for their mutual benefit. For instance, we are aware of one hospital system that has reported successfully contracting with physicians to provide ASC management services, with respect to an ASC not owned by the physicians. While many hospital executives do not view physicians as “managerial material,” this hospital system has apparently had good success paying physicians for bona fide ASC management services, with performance based compensation. The hospital achieves closer ties to the physicians, and the physicians, through their ASC management entity, gain access to another source of compensation for their services.

What legal concerns should physicians have when considering such joint ventures? The most problematic ventures, from a health care attorney’s perspective, are deals in which an existing business or arrangement is legally restructured so that nothing changes except for the flow of dollars. If the physicians are not contributing anything new to the venture, such as money, business expertise or assumption of business risk, but are (in the end) capturing additional dollars out of existing referral patterns, then the OIG may conclude that the only reason for the transaction is to reward the physicians for their referrals. This is type of arrangement that the OIG warned against in its 2003 “Special Advisory Bulletin” on “Contractual Joint Ventures” and more recently in its December 2004 Advisory Opinion criticizing a pathology “condo lab” arrangement.

The better scenario, from the health care attorney’s perspective, is a de novo venture where there will be a new equipment acquisition, new building or truly new service, with the physician investors contributing money, expertise or at least business risk. With such a contribution or commitment by the physicians, the arrangement may be have unacceptably high risks from a legal perspective.

Daniel M. Bernick, Esq., M.B.A. is an attorney and shareholder of Health Care Law Associates, in Plymouth Meeting, Pa.

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