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New State Legislation Provides Physicians with Added Incentive to Team with Hospitals?

John D. Fanburg

AN ALTERNATE OF THIS PUBLICATION CAN ALSO BE FOUND HERE

Over the past three decades, ambulatory surgical centers (ASCs) have developed all across the nation at an exponential rate. Insurance providers initially encouraged the development of these facilities believing that patients could receive better, more efficient and ultimately less expensive care than at hospitals. But the true catalyst fueling the development of ASCs came in 1982, when Medicare approved reimbursements to such facilities. Indeed, since 1982, the numbers of ASCs have grown more than tenfold from a mere 293 locations to more than 3,500 locations.1 Although some of these ASCs involve joint ventures between physicians and hospitals, the vast majority are exclusively physician-owned.

Physicians have historically preferred to undertake the business and financial risks alone with the hopes and the potential of reaping greater profits. Recently, however, the trend toward and adoption of certain state laws that place restrictions on ASC ownership, like those adopted in New Jersey, have encouraged physicians to revisit and revaluate teaming with hospitals.

Hospitals across the nation have often complained to their legislature that physician-owned ASCs create an uneven playing field for hospitals because of how these facilities tend to siphon away better-insured patients from hospitals, leaving hospitals to absorb the cost of Medicaid, charity care and no-pay patients. State and federal governments have long subsidized these struggling institutions in an effort to maintain a certain level of access for its citizens. Legislation, like New Jersey’s Codey Law, may be viewed as a means to reduce or stabilize the financial burden that struggling hospitals place on state budgets. The Codey Law imposes limitations on who may own new ASCs and greatly hinders the ability of physicians to own and operate new ASCs. Legislative initiatives, like the Codey Law, become especially appealing in challenging economic times, where state revenues are coming in short while government subsidies for hospitals continue to grow.

In the wake of the decisions such as Garcia v. Health Net of New Jersey and Health Net of New Jersey v. Wayne Surgical Center, the New Jersey legislature responded by promulgating amendments to its existing Codey Law, which were ultimately approved by the legislature and signed into law on March 23. The Codey Law represents New Jersey’s attempt to mirror or codify the federal Stark Law, which generally prohibits a physician from referring a Medicare patient for designated health services to an entity if the physician has a financial relationship with the entity unless an exception applies. The Codey Law, takes Stark two steps further, by expanding its grasp to encompass not only Medicare and Medicaid patients but to all patients, as well as severely limiting exceptions for these financial relationships.

The recent Codey Law amendments increase oversight of existing ASCs by requiring registration, accreditation and compliance with regulations of New Jersey’s Department of Health and Senior Services (NJDHSS). Of greater significance, the Codey Law amendments impose a bar on physician participation in new ASCs, as well as severely limiting the scope of the Codey Law’s “extension of practice exception.” While the amendments allow for the creation of some new ASCs, these new licensees are limited to those changing ownership, relocating or those teaming with New Jersey hospitals or medical schools.

Although the Codey Law is not binding on ASCs outside of New Jersey, its adoption creates and influences the decision of other states regarding ASC regulation. For instance, Washington’s Legislature has a similar bill pending on its legislative voting floors. While Washington’s legislation is not nearly as restrictive as the Codey Law, it nonetheless establishes that state legislatures are leaning towards more regulation over referrals to, and financial interests in ASCs than what is currently in place under the Stark Law.

As a result of these new legislative ownership restrictions, joint ventures are becoming a more sought-after option. The opportunity to create a joint venture exists in other states across the United States, particularly since many anticipate that the Codey Law is an indication of what is likely to happen nationally. By pursuing a joint venture with physicians, hospitals have an opportunity to preserve some of the patient base they believe eroded with the proliferation of physician-owned ASCs. Hospitals may also have resources (e.g., physical plant facilities, technology, administrative expertise, etc.) to bring to the new venture such as an in-kind capital contribution, resources that may be costly to reproduce or require a prolonged implementation process.

On the other hand, physicians have the opportunity to share risk and tap other potential sources of capital. Perhaps the biggest benefit of partnering with a hospital is the economies of scale derived from sharing the real estate component, including the medical equipment, and not just the operational benefits. Additionally, working with a hospital provides physicians with an easier way to secure financing for line of credit, lower interest rates and access to equipment and lease guarantees in developing an ASC. In many cases, lenders are requiring recourse loans from physicians to protect themselves against defaults. Both sides may benefit from a more collaborative working relationship that enhances the knowledge, expertise and visibility of both hospitals and physicians in this ever competitive market.

Before consummating these joint ventures, hospitals and physicians should carefully negotiate and agree on major business considerations such as capital requirements, equity and management issues, restrictive covenants, and termination provisions. Decisions like whether to create a freestanding ASC or hospital campus-based ASC, whether to purchase or lease ASC space, whether partners should directly develop the ASC or contract an outside consultant to develop the ASC, or how many operating suites the ASC should have, affect the ASC’s start up costs and ultimately the parties’ capital requirements.

Understanding what each party brings to the arrangement can aid in allocating equity in the ASC. Generally, physicians feel strongly that the success of the ASC is largely based on their medical reputation, services, and following and therefore typically demand greater ownership interest. On the other hand, hospitals will leverage their own reputation and vast resources in negotiating equity interest. While management and control (i.e. voting rights) of the ASC are obviously tied to equity negotiations, majority owners may still decide to contract an outside management company to run the ASC’s day-to-day operations.

Parties can choose to adopt restrictive covenants that limit participation in new ASC during the course of the joint venture. These restrictive covenants may stymie a hospital’s ability to enter into additional joint ventures with physicians of different medical specialties, and hinder a physician’s ability to establish additional joint venture with other hospitals. Lastly, joint venturers should decide whether parties may terminate with cause or without, how to calculate buyout value upon termination, and whether penalties should be imposed for termination, especially termination without cause.

While these ventures represent viable alternatives to physicians and doctors alike, there are still a myriad of laws that have to be complied with, both on the state and the federal level. Should these physicians or hospitals decide that venturing is the right approach, it is as important as ever that hospital-physician ASCs be properly structured to comply with these laws. Hospitals and physicians seeking to enter into such joint ventures may wish to consider obtaining the assistance of legal counsel who are well-versed in the Codey Law and other state and federal healthcare laws including but limited to anti-kickback law, Stark law, non-profit tax law and antitrust law prior to entering a joint venture.