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The health care landscape in New York has undergone dramatic changes over the past 15 years. Many formerly independent hospitals have merged, been taken over or have been absorbed into larger systems. These consolidations have come about in response to a variety of factors including the rise of managed care, the deregulation of hospital inpatient rates, the encouragement of competition where little or none previously existed, and the dire financial straits experienced by some facilities. Other motivations spurring the formation of these systems have included prospects for improved quality of care; integration of clinical and support services; reduced operating costs; stronger negotiating positions with HMOs, managed care organizations and other third party payors; and access to better credit and financing options. The typical model for these systems consists of a not-for-profit parent corporation or foundation sitting atop one or more licensed facilities such as hospitals, clinics, and nursing homes. These parent corporations fall into one of two categories: “active” or “passive.” A “passive” parent, has little or no ability to take on the central decision-making power to accomplish systemic goals. Instead, it has a much lesser role, limited to such functions as serving as the corporate member; appointing trustees; approving amendments to corporate bylaws; recommending that its affiliates consider adopting policies and procedures; and making recommendations regarding strategic direction, compliance, legal services and administrative support services. A system, however, is more likely to want to have an “active” parent with the ability to exercise centralized powers and to implement programs and policies to accomplish systemwide goals. The distinction between an “active” and “passive” parent is determined by state regulations enumerating activities that constitute the active operation of a hospital under Article 28 of New York’s Public Health Law (PHL). Law PHL Article 28 governs the licensure and regulation of hospitals, hospices, nursing homes, diagnostic and treatment centers, ambulatory surgery centers and certain other health care facilities (collectively referred to in the PHL as “hospital”) and sets forth the requirements for their establishment and incorporation. Hospitals and operators of hospitals must first file “certificate of need” (CON) applications with the Department of Health. These applications are reviewed by department staff according to criteria such as financial feasibility, the “character and competence” of the proposed operator, the need for such a facility in the community, and so on. The Health Department staff then forwards the application along with the department’s recommendation to the New York State Hospital Review and Planning Council, which in turn reviews these materials and makes its own recommendation. The application then is submitted to the New York State Public Health Council, which has the final say on any establishment application. 1 CON approval must be obtained for the establishment of any hospital and to file the certificate of incorporation of any business or not-for-profit corporation whose purpose is to establish or operate a hospital, or to solicit contributions for such purpose. 2 In addition, CON approval is required for a change in the operator of a hospital. 3 The question as to what constitutes the “operation” of a hospital arises when a corporation seeks to become either the “passive” or “active” parent of an Article 28 licensed facility. A hospital’s corporate parent must be licensed under Article 28 when it is an “active” rather than a “passive” parent, since an “active” parent will be considered an operator of the hospital. 4 Under the Health Department’s regulations, an Article 28 licensed hospital must maintain management control over its operations. 5 This mandate is also reflected in 10 NYCRR (New York Codes, Rules and Regulations ) �600.9(d) which states: (1) Except as provided in �405.3 of this title, the governing authority or operator may not contract for management services with a party which has not received establishment approval. (2) The criteria set forth in this paragraph shall be used in determining whether there has been an improper delegation to the management consultant by the governing authority or operator of its responsibilities: (i) authority to hire or fire the administrator or other key management employees; (ii) maintenance and control of the books and records; (iii) authority over the disposition of assets and the incurring of liabilities on behalf of the facility; (iv) the adoption and enforcement of policies regarding the operation of the facility. In essence, a hospital may not turn over control of its management to a party that has not received Public Health Council approval. 6 Therefore, if a parent corporation seeks to exercise control over the management of a hospital, the parent itself must be licensed under Article 28. 7 More Regulations Other regulations enumerate specific actions that constitute hospital operation. For example, 10 NYCRR �405.1(c) provides that an entity is an operator of a hospital if it has decision-making authority over any of the following: (1) appointment or dismissal of hospital management-level employees and medical staff, except the election or removal of corporate officers by the members of a not-for-profit corporation; (2) approval of hospital operating and capital budgets; (3) adoption or approval of hospital operating policies and procedures; (4) approval of certificate of need applications filed by or on behalf of the hospital; (5) approval of hospital debt necessary to finance the cost of compliance with operational or physical plant standards required by law; (6) approval of hospital contracts for management or for clinical services; and (7) approval of settlements of administrative proceedings or litigation to which the hospital is party, except approval by the members of a not-for-profit corporation of settlements of litigation that exceed insurance coverage or any applicable self-insurance fund. If a parent corporation satisfied these criteria or is otherwise found to have “active” control in these areas, it will be considered an operator, and therefore must seek Article 28 establishment approval to operate its hospital, nursing home or other Article 28 licensed affiliates. Moreover, any management contract with an Article 28 licensed facility must be submitted for approval by the commissioner of health. 8 The regulations also prohibit the sharing of revenues for providing health related services between an Article 28 licensed entity and a nonlicensed entity. 9 Therefore, if an Article 28 licensed hospital shares any of the revenue that it receives for health-related services with its corporate parent, the parent must also be licensed under Article 28. That is to say, a parent corporation � whether active or passive � must be licensed under Article 28 to be a hospital operator if it intends to share in the revenues of any of its affiliated Article 28 licensed entities. Antitrust Filings In the course of creating a health care system, what is sometimes overlooked are the New York State regulatory implications that are triggered by representations made in the course of federal antitrust review. These arise most often during Hart-Scott-Rodino review. The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act) requires a 30-day premerger notification to the Federal Trade Commission and the Department of Justice for transactions satisfying several criteria. 10 One of the criteria is the “size of the transaction” inquiry, which requires that the transaction result in the acquiring party holding either: (1) 15 percent of either the voting securities or assets of the acquired party, or (2) voting securities and assets of the acquired party with a total aggregate value of $15 million or more. 11 If the transaction meets either one of these criteria, it must be reported unless one of the exceptions in the HSR Act applies. 12 A corporate parent may satisfy the HSR Act’s requirements as the “acquiring party” if it attains a significant degree of control over any one of the licensed providers under the “size of the transaction” inquiry. If such control includes the activities enumerated in the state regulations, it is quite possible that the corporate parent, as the “acquirer for HSR purposes,” could also be seen as an operator for PHL establishment purposes. In addition, the HSR Act’s use of “acquiring” and “acquired” to describe the parties to the proposed transaction implies that the resulting organization will be one in which the acquiring party has an “active,” as opposed to “passive,” role in the management of the acquired party, thus making the acquiring party a de facto operator requiring licensure under PHL Article 28. Conclusion New York’s regulatory scheme for Article 28 licensed hospitals was carefully designed to assure that those facilities and their governing bodies would be directly accountable to the Department of Health for the quality of care provided to the patients served by those facilities. As multi-hospital systems have evolved under the control of active parent corporations, most of these systems have sought and obtained appropriate establishment approval for their corporate parent. However, every system with a passive corporate parent should periodically review the scope of the parent’s involvement with its licensed affiliates to determine if it has crossed the line into being an active parent, and thereby need establishment approval under PHL Article 28. Francis J. Serbaroli is a partner at Cadwalader, Wickersham & Taft. He is the author of “The Corporate Practice of Medicine Prohibition in the Modern Era of Health Care,” published by BNA. Disclaimer: Mr. Serbaroli serves as a member and vice chairman of the New York State Public Health Council. The views expressed and any statutory and regulatory interpretations included in this article are the author’s and do not necessarily represent the views of the Public Health Council or the Department of Health. Endnotes: 1. See N.Y. Public Health Law �2801-a(1). 2. Id. 3. See PHL �2801-a(4)(a). 4. Under these regulations, an active parent equals a hospital operator. 5. See 10 NYCRR ��405.2, 405.3. 6. Id. 7. Id. 8. 10 NYCRR �505.3(f)(2). 9. See 10 NYCRR �600.9(c) (“An individual, partnership or corporation which has not received establishment approval may not participate in the total gross income or net revenue of a medical facility.”). 10. See 15 USC �18a. The first criterion is the “in-commerce” test, which requires that one of the parties to the transaction be engaged in interstate commerce or in an activity affecting interstate commerce. See 15 USC �18a(a)(1); Jonathan Choslovsky, “Agency Review of Health Care Industry Mergers: Proper Procedure or Unnecessary Burden?,” 10 Admin. L.J. Am. U. 291, 300 (1996). The second criterion is the “size of the parties” test which requires one of the parties to have annual net sales or total assets of $100 million or more and the other party to have net sales or assets of $10 million or more. See 15 USC �18a(a)(2)(A)-(C); Id. 11. See 15 USC �18a(a)(3). 12. See 15 USC �18a(c).

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