Business Dealings with Entities Under Investigation: 
Look Before You Leap

Scenario 1: A hospital was negotiating with a group of doctors who were organizing a medical practice to provide relocation assistance and other support. As the parties were close to negotiating final documents, the local newspapers and national press reported that the System to which the hospital belonged was under investigation in a different state for potential fraud involving physician relocation arrangements. 

Scenario 2: Two medical group practices are considering a merger in order to take advantage of being a larger group practice with complementary services and geographic markets. During the due diligence phase of their respective reviews of the other’s business, the attorney for one of the practices identified a potential problem with a contract in place with the other practice that raised issues under the Medicare/Medicaid rules related to billing, coding and services being provided “incident to” the professional services. 

What do you do? What does this mean to the transaction? Do you close the deal or walk away?

In the current environment of heightened regulatory scrutiny and investigations, these are not uncommon occurrences. Unfortunately, if the innocent party is not represented by counsel familiar with health care law, there can be significant and unintended consequences related to successor or vicarious liability. So, how can a physician or group of physicians be protected from the inherent uncertainties that come with transactions that involve entities either “at risk” for or under scrutiny by regulators?

The answer is that you can never have complete protection, but you can certainly inform yourself of the risk and, depending on your tolerance for risk, take certain steps to mitigate your exposure when dealing with “troubled entities.” These steps include (1) appropriate “due diligence” review of the troubled entity; (2) adequate contractual and structural safeguards and (3) sufficient reserve or “securitization” of the troubled entity’s commitments.

The Importance of Due Diligence

One of the most important ways to learn about the scope of a troubled entity’s exposure is to engage in a careful “due diligence” of that organization. Due diligence involves the review of all relevant documents, including organizational documents, contracts, financial information, licensure, liability claims and related information that describes the organization’s business sufficiently to allow a risk analysis. 

Due diligence should involve a knowledgeable and experienced multidisciplinary team who can review the legal, financial, governance, reimbursement/billing/accounts receivables, managed care and risk management issues. Because of regulations such as Medicare fraud and abuse and HIPAA, the transaction must be carefully structured in order to assure compliance. In addition to the regulatory issues, there should be close attention paid to the assessment of fair market value, particularly when the arrangement involves a hospital and a physician.

Due diligence is important because of the possibility of successor liability. This is a risk inherent in any merger or acquisition, regardless of whether a party is under investigation or not. The general rule is that a company that acquires the assets of another company does not assume its debts and liabilities. However, there are several exceptions that extend liability to the purchaser. These exceptions include: 
(1) express or implied assumption of liability; 
(2) consolidation or merger that retains the essence of the “troubled entity,” and 
(3) continuation of the seller entity “post-acquisition or merger.” 

In particular, Medicare will attempt to hold the purchasers of the assets of Medicare providers liable for Medicare debts of the prior owner. This is particularly true where the successor organization attempts to use the seller’s provider number, which is often retained in order to assure continued cash flow.

Do You Do the Deal?

In Scenario 1, the physicians decided to discontinue their negotiations and walked away from the deal. They did not have the appetite for incurring any risk exposure, including the potential public relations issues associated with the System. 

In the second Scenario, the physicians decided to do the deal with certain safeguards. These safeguards included: 
(1) indemnification provisions; 
(2) rights to modify, amend or terminate third party contracts; 
(3) well-defined liability allocation; 
(4) reserving funds to cover identified exposures; 
(5) adequate representations and warranties and 
(6) unwind provisions. 

Other ways to secure against potential problems related to financial risk include: 
(1) holdbacks, 
(2) escrow/indemnity trusts, 
(3) letters of credit, 
(4) securing other collateral and 
(5) reviewing the balance sheet of the troubled entity. 

Transactional-risk insurance may be an option for certain transaction risks such as representations and warranties, tax, outstanding litigation and successor liability. However, these are not “off-the-shelf” products since each addresses a particular risk. The challenge is to determine whether the cost of the insurance outweighs the other risk financing/legal protection tools.

Conclusion

In the final analysis, there is no excuse for a careful “due diligence” review as the best form of risk avoidance/protection. Knowing the risk allows the development of protective language in the legal documents for the innocent party. Finally, the ability to secure against exposure may be a viable alternative for those who wish to do the deal even if the other entity is under investigation or is subject to potential liability. The availability to transactional liability insurance may be an option for certain transactions.