Mergers and Acquisitions and the Health Care Industry

October 3, 2024
Publications

The American health care industry continues to navigate the aftershocks of the acute phase of the COVID-19 pandemic. According to a recent report published by the American Hospital Association (AHA), increasing supply, labor and administrative costs to hospitals continue to outpace increases in reimbursement rates by government payers. (See “Hospitals and Health Systems Continue to Face Rising Costs, Economic Pressures,” American Hospital Association, May 2, 2024.) While hospitals have achieved some stabilization in the past year, the same report highlights the continuing challenges faced by the industry, including the ability to meet the demand for care, increased compliance requirements, investments in updated technology, including adding in protections against the ever-increasing slate of cyberattacks, as well as infrastructure improvements to prepare for the next health care crisis.

These pressures have led to a slower pace of hospital mergers and acquisitions than seen in pre-COVID years, with health systems focusing on streamlining operations and choosing partnerships or sales agreements in some instances to ensure they are able to continue to serve their communities. When considering such a merger, performing thorough due diligence is more important than ever before to safeguard any potential financial or regulatory risks. When reviewing the financial records of a potential acquisition, the acquiring party should determine whether there are any loans that would need to be satisfied prior to the acquisition. If the loans may be assigned to the acquiring party, the acquiring party will need to carefully review the terms of the loan to better understand when payments are due and then review the current and projected revenues of the facility to ensure that the revenues will cover the loan payments.

From a regulatory perspective, if the hospital to be acquired has been facing difficult financial circumstances, the acquiring party should carefully review the most recent survey results from the Department of Health and any accrediting bodies (for example, the Joint Commission) to determine if those circumstances have led to lapses in patient care or facility maintenance.

Hospitals are required to be in compliance with both state and federal requirements in order to maintain their operating license and their ability to receive payment from Medicare or Medicaid. These survey results can signal what immediate investments will be needed once ownership is transferred, including such items as the need for increased staffing, capital improvements to the safety infrastructure of the facilities or other items impacting the care and safety of patients. Additionally, third-party payor contracts should be reviewed to determine what sources of income are available to the hospital as well as what conditions those contacts may place on a change in ownership of the facility. The potential buyer will also want to receive a full disclosure of any outstanding fines or penalties placed on the facility by a regulatory agency.

Another key factor in a hospital merger or acquisition is an assessment of any outstanding bonds encumbering the facility. The acquiring party should carefully review any and all bond indentures and loan agreements for bond financing. If there are bonds outstanding, the trustee may need to be involved to ensure that any assets encumbered with bonds are appropriately released. For some bonds, an officer’s certificate from the entity transferring assets may be required to ensure that there are sufficient assets to cover the debt service.

Prior to closing a transaction, a number of regulatory approvals must be obtained. First, in Pennsylvania, if the hospital is a charitable entity, the Office of Attorney General must review each transaction to ensure that the public interest in the charitable assets of the hospital is fully protected. See (https://www.attorneygeneral.gov/protect-yourself/charitable-giving/review-protocol-for-fundamental-change-transactions-affecting-health-care-nonprofits/). At least 90 days prior to the transaction, the parties must provide written notice of the proposed transaction to the Attorney General, including detailed information such as the proposed transaction documents, corporate organizing documents, audited financial statements of both parties and related entities, tax documents, and any available information shedding light on the potential impact of the transaction on the availability or accessibility of healthcare in the surrounding community. Additionally, if the value of the transaction could implicate federal antitrust laws, it is currently best practice to provide a separate notice to the antitrust section of the Office of Attorney General as that office can bring an action in federal court to block the merger. However, a proposed House Bill 2344 would make this notice requirement for hospital and health system mergers of at least $10 million. (The General Assembly of Pennsylvania, House Bill 2344, Session of 2024).

The Pennsylvania Department of Health (DOH) must also approve of the transaction prior to its closing. The parties must apply to the DOH, completing a change of ownership application (CHOW) and providing additional information, including the proposed transaction documents, IRS documentation and corporate organizing documents. Various other regulatory notices may be required depending on the licenses held by the facility. Examples are notices to the DOH Bureau of Laboratories, the Pennsylvania Department of Environmental Protection and the U.S. Drug Enforcement Administration.

With the increased challenges and compliance requirements facing the American health care industry, it is crucial for hospitals and health care systems to routinely evaluate whether there are merger and shared services opportunities with other hospitals and health care systems. This due diligence will ensure that the hospitals and health care systems are well-positioned for the ever-changing regulatory and financial demands facing the industry.

Christina Duty, of counsel with McNees Wallace & Nurick, is a health care regulatory and compliance attorney serving clients from Pittsburgh. She advises health care providers, including hospitals, health systems and physician practices as well as health insurance companies and represents clients faced with government agency investigations, audits and reviews. She can be reached at cduty@mcneeslaw.com or 412-227-2574.

Martha “Frannie” Reilly is co-chair of the firm’s public finance and government services group and chair of the firm’s charitable & nonprofit and environmental, social and governance (ESG) groups. Serving clients from Devon, she advises charitable and nonprofit organizations on fiduciary duties, compliance, planning and other matters. She can be reached at freilly@mcneeslaw.com or 484-329-8036.