In recent years there has been an increase in the number of business combination transactions in the health-care industry. In 2011 alone, there were 86 hospital mergers and acquisitions, the highest ever in the last decade. These transactions can take many different forms, from mergers, sales of assets or stock, to affiliations and other strategic transactions. Many of these transactions are driven in part by changes in reimbursement and new delivery-of-care models spurred by health reform. Health-care providers considering a transfer of ownership must understand that it can be a complicated process triggering various state and federal regulatory approvals.

Even before the Supreme Court’s decision upholding the Patient Protection and Affordable Care Act, hospitals and other health-care providers have been exploring consolidation and integration strategies as health-care reimbursement increasingly moves from fee-for-service to value-based purchasing, bundled payments and other various pay-for-performance mechanisms.

A confluence of other factors is also causing the spike in mergers, acquisitions and affiliations, such as declining operating margins from decreasing revenues and increasing costs, and the pressure to maintain market share by making major capital expenditures in infrastructure and information technology. For many smaller or single hospital systems, partnering with a larger system can ease the pressure to streamline operations by spreading costs over a larger revenue base, improving negotiation power with payors, and providing the much needed capital to invest in physician alignment and other health reform-related models of delivering of care.

The Transaction Process

As hospitals pursue these consolidation transactions, it is important to have a basic understanding of the transaction process. Multiple considerations come into play when structuring the transaction (i.e., transfer of membership or stock vs. sale of assets vs. merger), including, for example, successor liability (e.g., under Medicare), the tax status of the buyer (i.e., for-profit vs. nonprofit) and reimbursement concerns (e.g., assuming payor and Medicare participation agreements vs. enrolling a new entity).

As a threshold issue, it is important that the appropriate confidentiality agreements are executed and that the board has approved discussions with third parties. It is also important that the board’s decision to sell or merge or undertake a similar transaction is well documented in board minutes and other documents, including documentation of the board’s reliance on any consultants or outside counsel. These are important considerations that will have to be demonstrated in connection with obtaining regulatory approvals.

Often the parties will sign a letter of intent which captures the major transaction points agreed to by the parties, such as financial terms and deal structure. Thereafter, the due diligence phase begins. While this phase is dominated by the buyer requesting information from the seller, it is important that the seller also perform “reverse” due diligence for the board to consider in its final decision. An issue often of concern during this phase is the disclosure of confidential, proprietary and sensitive information that could either result in the seller’s violation of its contractual obligations to third parties or a violation of law.

The next phase is the negotiation and execution of a definitive agreement. Key issues often include financial terms, governance rights, management structure and succession, the treatment of employees and benefit plans, the scope of the buyer’s termination or “walk” rights, the seller’s representations and warranties, indemnification and restrictive covenants. Once the definitive agreement is executed, the parties will begin the process of obtaining regulatory and third-party approvals and consents.

State Health Care Regulatory Approvals

• Certificate of Need Review. New Jersey hospitals seeking a “transfer of ownership” must obtain approval from the Department of Health and Senior Services (DHSS) before the transaction occurs pursuant to the Certificate of Need (CN) review process. N.J.A.C. §8:33-3.3(a)(1). Failure to obtain CN approval prevents the acquiring entity from obtaining the necessary license to operate the hospital and results in a daily penalty. N.J.A.C. §8:33-3.3(c).

As an initial matter, DHSS will determine whether or not the CN application is “complete” and will notify the applicant of specific deficiencies, called “completeness questions,” to which the applicant must respond. Once an application is deemed complete, the statutory timelines outlined in the CN law and regulations are triggered.

Thereafter, the application will be reviewed by the State Health Planning Board, which will hold a public hearing and make a recommendation to the commissioner of DHSS, who has the final authority to approve or deny the application. The commissioner’s decision can be appealed by the applicant or an affected party. Following CN approval, the buyer must apply to the commissioner for transfer of the selling hospital’s license.

• CHAPA Review. Nonprofit hospitals in New Jersey must also obtain approval from the attorney general (AG) and the Superior Court of New Jersey of any “acquisition” under the Community Health Care Assets Protection Act (CHAPA). An “acquisition” is defined as the purchase, lease, exchange, conversion, restructuring, merger, division, consolidation, transfer of control or other disposition of a substantial amount of assets or operations, whether through one transaction or a series of transactions with one or more persons or entities.

Under CHAPA, an application is first submitted to the AG who will typically respond with a series of completeness questions requesting more information. The AG will consider several factors when reviewing the application, such as the process involved in valuing the acquisition, whether conflicts of interest were disclosed, and whether the board of the selling hospital exercised due care in negotiating the terms of the deal, including whether it used the assistance of experts.

The AG will consider additional factors if the transfer involves a for-profit entity such as, for example, whether a fair price is being received by the seller and whether charitable funds are placed at unreasonable risk (e.g., by seller financing). In addition, the parties may be required to set aside assets as a charitable obligation or to fund the appointment of an independent health-care access monitor. N.J.A.C. 26:2H-7.11(i)(1).) The AG will retain oversight of the charitable obligation once it is set aside in a charitable trust or other tax-exempt entity. The governing body must submit an annual report describing all financial activities and the report must be made public. N.J.A.C. § 26:2H-7.11(h)(3).

Another issue that may come up as part of the AG’s review is the treatment of restricted gifts made to the selling hospital. If the intent of the donors can no longer be fulfilled, then these gifts will likely have to be redirected under the cy pres doctrine, which may included as part of the court approval proceeding under CHAPA.

Once the application is deemed complete, the AG and the commissioner of DHSS must hold a public meeting on the proposed acquisition where various interested stakeholders (e.g., employees, management, unions, public interest groups, etc.) are able to voice their support or opposition to the transaction. Thereafter, the AG will decide whether to support the acquisition (with or without modification/conditions), or oppose the acquisition. N.J.S.A. 26:2H-7.11(b).

Following the AG’s review, the hospital applies to the Superior Court of New Jersey for approval. N.J.S.A. 26:2H-7.11(l). The AG will advise the court as to its position on the transaction, however, the court has the final authority to determine whether the proposed acquisition satisfies the CHAPA requirements.

Other Federal and State Approvals/Issues

In addition to the above state health care-related approvals, many business consolidation transactions will require various other approvals, including under some or all of the following major laws:

• Antitrust Laws. The transaction could be subject to the federal Hart-Scott-Rodino Act, which requires that entities contemplating an acquisition transaction in excess a certain dollar threshold inform the Federal Trade Commission (FTC) and the Department of Justice (DOJ) before the transaction takes place. (15 U.S.C.S. § 18a.) Currently, this threshold is $68.2 million, and it adjusts annually based on the consumer price index. The parties must submit a premerger notification to the FTC and DOJ, along with certain information regarding each company’s business. The agencies will analyze the anticompetitive impact of the transaction and may request additional documentation, which could delay the deal closing timeline.

• Medicare/Medicaid Change of Ownership. Hospitals must also provide notice to, and in some cases obtain approval from, the Centers for Medicare and Medicaid Services and the New Jersey Department of Human Services in connection with certain changes of ownership or changes of information.

• Federal and State WARN Act. Certain types of business consolidations may also trigger the federal Worker Adjustment and Retraining Notification Act of 1988 (WARN), and New Jersey’s equivalent, Millville Dallas Airmotive Plan Job Loss Notification Act. Notably, while WARN has a sale of business exception, New Jersey’s Act does not contain the same exception. Thus, if notices are to be given, the timing of these issues must be carefully orchestrated with the timing of receipt of other approvals, such as under the CN law and CHAPA.

The number of hospitals and health systems that are considering consolidation and integration transactions is on the rise. Orchestrating these types of transactions can be a complex and time-consuming effort. A common pitfall is failing to recognize the complex regulatory approval scheme and thus not setting reasonable expectations for consummating these transactions. Both buyers and sellers should thoroughly understand these issues in order for their transaction to proceed smoothly and to avoid potential legal challenges along the way. •