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With 92 total transactions announced in the healthcare sector in 2019, the high level of M&A activity seen throughout the industry is showing no signs of slowing.

Driven in large part by provider responses to the challenges and opportunities created by the COVID-19 pandemic, national and state healthcare reform initiatives, the introduction of new technology, and disruptive new entrants to the healthcare market, many experts expect this trend to continue for some time.

As health systems and hospitals consider their future, M&A transactions or strategic partnerships are viable options to pursue future growth in today’s evolving marketplace. As we discussed previously, there are many considerations these organizations must take into account before pursuing a combination. 

However, for organizations that have found a suitable partner and believe that they’re ready to sign on the dotted line, there are still many legal and strategic considerations to take into account before finalizing a transaction. There are various stages of deal negotiations, and all of them require close attention and consideration.

As healthcare companies navigate this process, there are a few areas to pay particularly close attention to as negotiations progress:

Negotiating the Letter of Intent

The letter of intent (LOI), sometimes informally referred to as a term sheet, is a critical aspect of any transaction and sets the tone for the business deal. This document contains binding and nonbinding provisions. The binding language often includes confidentiality provisions that protect the selling party’s confidential and competitively sensitive information, such as reimbursement rates, employee salaries, and other information that could be used to a competitor’s advantage. It is crucial that this confidentiality language be air tight in order to protect the seller from its intellectual property falling into the hands of a competing organization. Standstill clauses, also known as exclusivity clauses, are typically included to prohibit the selling entity from speaking with other potential buyers during negotiations.

The nonbinding language of the LOI typically establishes the structure of the transaction, including basic deal points, and, most importantly, the purchase price (which is usually subject to confirmatory due diligence as outlined below). This section serves as an outline of the general terms and conditions that will be included in the definitive agreement, which will be negotiated after the LOI is signed.

The level of detail included in an LOI is one important aspect for both parties to consider. Even though a portion of the document is nonbinding, it can be difficult for a buyer or seller to go back and change the terms established in the LOI at a later date. The more terms and conditions that can be agreed upon in the LOI, the less room there will be for negotiation when putting together a definitive agreement later in the process. On the other hand, LOIs can include fewer details and be signed much more quickly, allowing the process to be expedited. However, these details will eventually need to be ironed out in the definitive agreement, which may then slow the process during this later stage.

Doing Thorough Due Diligence

While every buyer has some insight into the health of the company they’re seeking to acquire when negotiating the LOI, the due diligence process provides much more clarity into the target’s underlying financials and operations. There are a few areas that are worth paying particularly close attention to. For example, buyers must look for any trends that indicate a deterioration of financial performance and what might be driving them. Reimbursement issues, the company’s payor mix, and how these factors may have changed over time can also provide clarity into future revenue prospects. For example, some health systems rely heavily on Medicaid and Medicare reimbursement, which is typically not as lucrative as private payor arrangements.

Contractual agreements with payors and arrangements with other health care providers warrant close review. However, these arrangements typically contain competitively sensitive information like physician compensation or rate information. This data is typically not directly reviewable by the buying entity. In these situations, the seller often seeks to protect itself by contracting with a third-party consultant to review these arrangements from a black box perspective. Instead of providing specific rate information, these consultants can share with buying entities certain aggregate information, and certain non-sensitive information related to the agreements.

Review of all aspects of a seller’s business is critically important to a successful transaction.  In the health care context, the seller’s compliance plan and operational policies and procedures deserve a thorough review. Buyers should also review the seller’s medical staff bylaws and related documentation for potential issues regarding the professional staff. Any red flags in employment practices must be identified and addressed during this stage. Privacy and security concerns must also be addressed and are becoming increasingly more important given the potential for extensive liability in this area. Buyers should look into any potential HIPAA violations or cybersecurity vulnerabilities. The potential vulnerability of existing technology and data storage systems should be reviewed to ensure that they are not susceptible to undetected data breaches that could expose the buyer to future liability.

For any transaction to be successful, it is critical that all of the above areas of liability are identified and addressed early on in the negotiation process. Otherwise, health care buyers risk overpaying for an asset or engaging in a transaction that might not serve their long-term strategic interests.

Ironing out Definitive Agreements

Definitive agreements finalize crucial areas of the M&A deal. In this agreement, the seller must make representations and warranties regarding its existing business. For healthcare organizations, this means they must certify that they are in compliance with all healthcare laws and regulations. Representations and warranties must cover all bases, including privacy and security, reimbursement regulations, outstanding litigation, compliance matters, tax matters, and many more. Additionally, the definitive agreement should include disclosures by the seller when there is an exception made to a representation or warranty, typically referred to as disclosure schedules.

Negative covenant provisions outlining how a seller is to run their business between the signing of the agreement and the actual closing should also be negotiated. For example, these provisions could prohibit entering into new service agreements over a certain dollar amount, increasing compensation payable to employees, amendments to critical corporate or other documents, or otherwise operating outside of the normal course of business.  

Provisions regarding how the seller’s company will be operated after closing are also important and spell out how personnel will be treated after the deal is completed.  Sellers sometimes seek to negotiate specific assurances that buyers will retain employees for a certain time period, which may be impacted by existing collective bargaining agreements. These provisions also address if and how existing corporate leaders will be involved in the company’s operations going forward. They further outline who will assume positions on the board of directors or trustees and whether the seller will be able to retain certain board seats.

As opposed to a purchase price, many healthcare transactions, especially in the nonprofit context, are funded by the buying entity taking on a portion of the seller’s debt or agreeing to invest a certain dollar amount in the future after the deal closes, typically targeted to the seller’s capital needs. These arrangements are often outlined in the post-closing commitments section of the definitive agreement.

Definitive agreements must also include provisions that address remedies for breach. These remedies could range from termination of the agreement to an adjustment of the purchase price. Additionally, definitive agreements generally include indemnification clauses that outline a course of action should a breach be discovered. For example, if it is found that the selling entity failed to disclose a piece of information, misrepresented itself, or operated in any way that was determined to be a breach of the agreement after signing, the buying entity might be entitled to compensation after the deal is closed or terminated.

Locking Down Critical Regulatory Approvals

Most healthcare M&A transactions must receive some level of regulatory approval. But the required reviews vary depending on the type of transaction, the entities involved, and the states in which the organizations operate. Generally, the process can take anywhere from three to four months. Parties can typically push forward for a quicker closing in transactions involving a stock or membership substitution transaction. However, it is important to keep in mind that receiving approval may take longer if there is federal involvement, such as a Federal Trade Commission (FTC) review.

Receiving a blessing from regulators can take different forms. In some instances, entities are only required to notify regulators. Other transactions require review and formal approval. For any transaction with a purchase price exceeding the Hart-Scott-Rodino (HSR) threshold (currently $94 million), the buyer must file with the FTC and undergo a closer review.

Federal and state approval requirements generally track to licenses and permits that are held by the selling entity in order to legally operate. Centers for Medicare and Medicaid Services (CMS), the Drug Enforcement Administration (DEA), and the Nuclear Regulatory Commission (NRC) are federal agencies that require a notification and in certain circumstances the completion of agency forms. The Department of Education (DOE) on both the federal and state level may also need to be notified if there is a college or university affiliated with the hospital or health system being acquired, or if the seller operates a school of nursing. 

The respective state Department of Health (DOH) and Department of Human Services (DHS) in which the selling entity operates will also need to be notified. Each state department has its own review process, which can significantly influence the total time required to receive all approvals.  In certain circumstances a new license may be issued, sometimes requiring additional inspections.

Each state’s attorney general’s office may also require certain review and scrutiny of a proposed transaction. For some states, a mere notice is all it takes. Other state attorneys general benefit from statutory or regulatory language that requires their approval of any change of ownership. These can include certificate of need (CON) statutes that require approval of the transfer of a CON and may involve other state agencies. For example, New Jersey has a robust CON review process in addition to requirements for review of nonprofit hospital transactions under its Community Health Care Assets Protection Act (CHAPA), which requires the New Jersey attorney general, as well as other state agencies, to weigh in on and approve before a transaction can close.

Attorneys general typically rely on their parens patriae authority when it comes to the ownership transfer of nonprofit healthcare organizations. Parens patriae is a principle that provides governing bodies with the responsibility to protect certain citizens and assets that serve the public interest. This includes the ownership transfer of nonprofit healthcare systems, which are typically considered charitable assets.

In Pennsylvania, the attorney general’s office follows a nonprofit review protocol which covers all nonprofit healthcare transactions. The Pennsylvania attorney general and attorneys general in other states may also request or require nonprofit healthcare providers to appear in court to secure official approval before ownership can be transferred. Any transaction that involves the purchase of a nonprofit hospital or health system by a for-profit buyer can expect to come under more scrutiny than other types of transactions.

Closing Process Essentials

Beyond exchanging payment of the purchase price, there are several final steps to take before a transaction closes. There is documentation to produce that effectuates the sale. This usually includes changes or revisions to the selling entity’s articles of incorporation and corporate organizational documents. These amended documents must be filed with the department of state in the applicable jurisdiction.

There are bill of sale documents and various assignment and assumption agreements that may relate to contracts and leases or other aspects of the transaction. Officers’ certificates that confirm the satisfaction of conditions to closing and the truth and accuracy of the representations and warranties in the definitive agreement must also be signed.

There may also be ancillary documents that need to be executed upon closing. These could include transition-related agreements for services that need to be provided by the seller or third parties post-closing to allow for an appropriate transition.

The Importance of Experienced Counsel

While a merger, acquisition or other new partnership can unlock powerful new levels of growth, all healthcare transactions come with a certain level of risk. With so many critical aspects of a healthcare M&A agreement, any small oversight in the details can derail a successful transaction. This is why it is critical to retain legal counsel that has specific experience in the healthcare space and knows the business well. These professionals can also help expedite the regulatory approval process and ensure positive outcomes for both buying and selling entities.

Read additional articles in our Convergence: M&A in Healthcare series:

Healthcare M&A: The Case for Private Equity Investments in Medical Practices

Healthcare M&A: What Decision Makers Need to Know Before Partnering

Healthcare M&A: Unlikely Alliances in Healthcare: Payors and Providers Are Teaming Up to Create Value

Our transactional know-how is fueled by our extensive M&A client work. Over the last few years, Buchanan Ingersoll & Rooney has led 40+ major healthcare deals valued at more than $20 billion.