Uncertain State Approval a Growing Concern for For-Profit, Non-Profit Healthcare Transactions

With the influx of merger and acquisition activity in the healthcare market, it is expected that a certain number of deals would fall through. Any number of occurrences could end a potential transaction. Recently, though, it seems healthcare M&A has experienced deals that end before they are completed due to rejection from state attorneys general or governors during the review process.

For hospitals or health systems planning a merger or a partnership, regulatory and state review is to be expected. Rejection at the state level is not something the M&A industry often experiences and recent rejections have surprised the industry. “Some states have been very active in blocking deals,” says Bart Walker, JD, an attorney with McGuireWoods. “It may just be that some issues have not been on the radar and the industry is now forced to confront them. Overall, it has been a wake up call for the industry.”

There are a variety of reasons a transaction may not gain state approval. The type of organizations involved dictate different intensities of state reviews. Whether or not the deal involves two non-profits, two for-profits or whether the deal would transition a non-profit to for-profit status all impact the state review.

State approval is always going to vary. Each state has different regulations for healthcare transactions. For instance, in New York a non-profit organization cannot be purchased by a for-profit organization whereas in other states that sort of transaction may be allowed.

Generally, a merger between two non-profit organizations will not undergo as much state or regulatory scrutiny. “States tend to see mergers between non-profits differently. The review at the state level is generally going to be very minimal,” says Howard Peterson, a consultant and CEO of TRG Healthcare.

Recently, the healthcare industry has seen more for-profits – for-profit systems, hospitals and even private equity firms – acquiring non-profits. When a for-profit purchases a non-profit, the state review is more rigorous because of constitutional issues, protected service issues and even charitable asset issues. “Often, an attorney general will want to guarantee the non-profit charter(s) will be honored moving forward,” says Mr. Peterson.

Concerns for community needs, public interests and stability of the for-profit can also be issues that arise during state review and then become justifications for terminating a transaction. When a transaction does not appear to suit public interest or community needs, the governor or the attorney general may halt the deal, says Mr. Walker.

Recently, a planned three-way merger between Louisville, Ky.-based University Hospital, which was deemed a public institution, non-profit Jewish Hospital & St. Mary’s HealthCare, also in Louisville, and St. Joseph Health System in Lexington, Ky., was rejected after state review.

Kentucky Gov. Steve Beshear rejected the deal, saying it was “not in the best interest of the Commonwealth and therefore should not move forward” and “the risks to the public outweigh the potential benefits.” Gov. Beshear cited a report done by Kentucky Attorney General Jack Conway, which claimed “the deal rais[ed] unprecedented and complex legal and policy issues.”

Of particular concern was likelihood that the Catholic organization’s policies on certain reproductive and other issues would be extended to University Hospital, which received taxpayer funds. Denver-based Catholic Health Initiatives, the parent company of St. Joseph, would have had majority control over the new system. University Hospital, which is currently operated by the University of Louisville serves as a safety-net hospital, and its merger with a Catholic hospital system would have been the first of its kind in the United States. The issues of combining a public health facility with a private and religiously affiliated corporation led to the rejection by Gov. Beshear and Attorney General Conway.

When a transaction involves dissimilar organizations, the state’s attorney general will most likely place more focus on what the organizations would look like post-closing, says Mr. Walker.

Another recently rejected merger dealt with concerns for the public’s interest as well. California Attorney General Kamala Harris denied the sale of non-profit Victor Valley (Calif.) Community Hospital to for-profit Prime Healthcare Service Foundation, run by Calif.-based Prime Healthcare Services. Here the issue of a for-profit purchasing a non-profit complicated the state approval and may have ultimately contributed to Ms. Harris’ rejection.

Although these examples also deal with complexities related to private ownership and religious affiliation, they still highlight the complexities of transactions involving non-profits and for-profits. In order to improve the likelihood of deal completion, healthcare leaders should consider a number of issues while developing a transaction, especially those involving dissimilar organizations.

Charitable assets. In transactions involving non-profits, the assets of all organizations involved are subject to review. When a for-profit is involved, the review of charitable assets including gifts and donations is important. “If someone has given money to a non-profit for a specific purpose, there would need to be a plan to honor the terms of the original donation and any future donations,” says Mr. Peterson. The initial purpose of the donation would need to be honored going forward.

Non-profit status. Most non-profits maintain their status by providing access and care to underinsured and uninsured individuals. While some states will allow non-profits to be acquired by for-profit chains and even transitioned to for-profit status, generally, an attorney general will seek to ensure services to vulnerable populations will not be greatly cut. “An attorney general will try to determine whether those individuals will be protected under the new transactions terms,” says Mr. Peterson.

Demonstrate fairness. The number of hospitals in a region may affect whether a merger appears reasonable to an attorney general. “If there is a three hospital town and two hospitals are merging – the third hospital could complain they were not given fair consideration. Leaving a hospital out of the deal is not illegal; the parties involved would just have explain why one hospital was a focus and not another,” says Mr. Peterson. “Demonstrating fairness in the merger process is they key.”

Structure of board. “Attorneys general want to see the community have interest and representation in a hospital board so the community, which needs the services of the non-profit entities, will remain protected,” says Mr. Peterson. Merging organizations should address questions such as the following: How will the organizations merging configure the board of directors? Will you combine boards from each merging party? Is the board sufficient in terms of community representation?

Community programs and services. In addition to serving the un- or underinsured, non-profits offer needed services to the community. An attorney general will need to know what will become of important programs. “For instance, many non-profit hospitals have obstetrics departments for delivering newborns. Some hospitals close those departments due to malpractice issues or loss of profit. However, for community hospitals, one of the most used services is the obstetrics departments because community members need to deliver babies. If a non-profit merges and later closes the obstetrics department, a community may go unfulfilled. The attorney general would want to make sure such a situation would be unlikely to occur,” says Mr. Peterson. Hence, an organization needs to create a detailed plan for the future of hospital services.

Fair market value. A merger may face rejection if the attorney general does not believe the proposed purchase is fair market value for the hospital or organization and its assets. According to Mr. Peterson, an attorney general and the state court system will want to be convinced that the proposed price is fair. It is important for a hospital to use a valuation firm they trust. When hospitals and assets are over-valued, a merger can become complicated due to liability risks down the road.

Purchaser stability. Finally, an attorney general may look at the stability of the for-profit purchaser. Confidence in the entity to operate the hospital is necessary for state approval. “If the transaction involves a for-profit that has not previously operated in the state, the attorney general will look at the company background and its ability to operate the hospital or health system in a stable way,” says Mr. Peterson. If a non-profit were to be sold to a “fly by night” entity and the entity failed, the hospital would cease to operate and would fail to provide needed services to the community, says Mr. Peterson. If an attorney general determines the for-profit is not capable, they will not approve the merger.

The issues listed here are not comprehensive of all issues healthcare organizations may need to prepare for or deal with. The rejections of the University Hospital and Prime Healthcare transactions demonstrate the complexity of for-profit and non-profit transactions. Mergers involving dissimilar organizations mandate a more complicated state approval process. Organizations should prepare for a variety of questions from the attorney general, the governor, the community and employees will have a better chance of success.

By lexutor