Presenting a live 90-minute webinar with interactive Q&A Joint Operating Agreements in Healthcare Complying With Regulatory Requirements and Maintaining Tax-Exempt Status in Structuring Virtual Merger Arrangements WEDNESDAY, AUGUST 23, 2017 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: David T . Lewis, Founder, Lewis Health Advisors , Brentwood, Tenn. Elizabeth M. Mills, Senior Counsel, Proskauer Rose , Chicago The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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JOINT OPERATING AGREEMENTS IN HEALTHCARE David T. Lewis Lewis Health Advisors david.lewis@lewishealthadvisors.com
Presentation Outline • Drivers Behind Community Hospital Strategic Relationships • Legal Considerations Related to Community Hospital Transactions and Discussion of Structural Options • Structuring Joint Operating Companies • Tax Issues • Antitrust Issues • Regulatory Issues and Approvals • Due Diligence Considerations from Buyer and Seller Perspectives • Completing the Deal Structure from Letter of Intent to Full Integration 5
What Are Community Hospitals facing? Shortage of Physicians and Integration of Healthcare Healthcare Professionals Providers Capital De Decli line in n Constraints Adm Admis issio ions Growing IT Healthcare Infrastructure Reform/Regulatory Requirements Uncertainty 6
Major Pressures on the Health System • Credit Rating • Operating Costs Requirements • Capital • Employed Physician Requirements Losses • ICD-10 • Uncertainty about • Price Transparency reimbursement • Payer Mix Change • Health Insurance Exchange • No Medicaid Expansion 7
Hospital Acquisition and Consolidation Models • Clinical Affiliations • Facility Management Agreements • Joint Operating Companies • Long Term Leases • Nonprofit Mergers and Member Substitutions • Asset Purchase Agreements • Stock Purchase Agreements 8
Changing Landscape Low High Degree of Integration Emerging Structures Traditional For-Profit Joint Joint Transaction Venture Venture Structure Affiliation Management Sale of Joint Sale of Change of Merger Services Minority Operating Controlling Corporate Agreement Interest Agreement Interest Member High Low 9
Examples of Minority Interest Joint Ventures Minority Interest Joint Ventures 10
Alternative Models of Collaboration Management Joint Collaborative Services Agreement Operating Purchasing and Agreement “Best Practice ” Source: Kaufman Hall 11
Assessing the Need for the Joint Venture • Financial Considerations • Strategic Considerations • Importance of Mission • Board fiduciary duties including duty of care and duty of loyalty • Document decision process carefully • Engage consultants, financial advisors and legal counsel at the outset • Keep stakeholders informed 12
Joint Operating Company • A “JOC” is a legal structure that allows the joint operation of services and business activities among hospitals that are not jointly owned. • A Joint Operating Agreement or “JOA” allows participating hospitals to retain separate boards of directors, but turn over management functions to a separate entity. 13
Joint Operating Company, Cont’d • A JOC is formed according to the terms of a JOA, which is the formal legal agreement defining the terms of combined operations • Sometimes referred to as a virtual merger • May be used to integrate operations without actually transferring assets • Agreement sets forth financial relationships of the parties and distribution of profits and losses 14
Long-Term Facility/Operations Leases • Long-term lease (e.g., 20+ years) • Lessee takes control and is responsible for all operations, revenues, and expenses (e.g., capital expenditures, physical plan maintenance) • Lessee makes lease payments to lessor • Majority of these models are between a municipality/government entity and a for profit or nonprofit system • At the end of the lease term, hospital control reverts to lessor 15
Nonprofit Mergers & Membership Substitutions • Brings together two or more hospitals/health systems, combining assets and liabilities (may be separated by facility or region) • Generally cashless transactions (future capital commitments/other funding requirements/assumption of liabilities common) • Goal of strong integration; shared contracting; economies of scale 16
For Profit Stock or Asset Deals For Profit to For Profit Transactions • The purchaser buys the seller’s hospital and physical assets through stock or asset purchase • In an asset deal, the seller repays non-assumed debt and liabilities • In a stock deal, buyer accepts assets and liabilities, stepping into shoes of seller(s) 17
Joint Operating Agreements in Healthcare Elizabeth M. Mills, Esq. Senior Counsel Proskauer 70 West Madison Chicago, IL 60602-4342 emills@proskauer.com (312) 962-3538 August 23, 2017
Federal Income Tax Exemption Issues 19
What's The IRS Got To Do With it? • Section 501(c)(3) tax-exempt organizations must operate for exempt purposes • 501(c)(3) organizations can endanger their exemption if they conduct a trade or business unrelated to exempt purposes ("UBI") as a substantial part of their activities • 501(c)(3) organizations can't share profits with non-exempt entities or provide an equity-type interest to non-exempt entities • With very limited exceptions, tax-exempt bond-financed property can't be used, occupied, or owned by non-exempt entities - Or by tax-exempt organizations in UBI activities 20
Why do they care about control? • "Actual" hospital merger - Hospitals are brought together under common tax-exempt parent - Parent exercises structural control through director appointment and reserved powers - Related organizations are an "integral part" of each other and can share services and management without UBI • A JOA often doesn't have this type of structural control • Because of JOA bottom line sharing, IRS could view a non- exempt JOC as having equity-type interest in each participating system, or as exempt assets being used in an unrelated trade or business 21
Joint Operating Company Delegated Hospital Board Selection Parent A Parent B Appoint JOC directors Reserve powers over JOC organic changes Joint Operating Company* Appoint directors and exercise reserve powers Hospital Hospital Hospital Hospital A1** A2 B1 B2 * JO C board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** Each hospital retains its license, governing board, and assets 22
Joint Operating Company Parents Retain Board Selection Parent A Parent B Appoint JOC directors Reserve powers over JOC organic changes Appoint Appoint Joint hospital hospital Operating directors directors Reserve powers Reserve powers Company* over hospital over hospital organic changes organic changes exercise reserve powers Hospital Hospital Hospital Hospital B2 A1** A2 B1 * JOC board makes decisions for hospitals as their parent; supermajority requirements, but not class voting, permitted ** Each hospital retains its license, governing board, and assets 23
Tax Exemption for JOCs • Obtaining tax exemption for JOC is key to avoiding UBI and private use • The IRS examines four factors to determine whether JOC has equivalent of parent-subsidiary relationship with the participating hospitals and is eligible for tax exemption • Facts and circumstances analysis, based on IRS private letter rulings and training materials 24
IRS Factor 1: Delegation of Significant Authority over Participating Entities • JOC should have power to, e.g.; - Establish budgets - Establish strategic plans - Approve debt - Reallocate income among entities (financial integration) 25
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