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The healthcare integration strategies of the mid-1990s have had mixed results. While some hospitals have successfully implemented physician network initiatives, many have experienced significant losses. A recent Ernst & Young study estimates that 96 percent of hospitals reported average losses from their physician practices last year of $111,000 per doctor. Accordingly, many hospitals are exploring new ways of reorganizing their physician relationships. In some cases this includes practice divestiture. This article explores some of the legal considerations pertinent to divesting practices.

In many respects, the legal aspects of a practice divestiture are similar to those of the acquisition of a practice. The regulatory issues encountered will also be the same as when purchasing the practice, i.e., anti-referral laws and tax exemption considerations. Certain important contractual covenants may also be similar. A critical difference, however, is the reversal of the parties' roles. This is important to consider when negotiating the key terms of the transaction. A hospital will want to exercise caution regarding the representations and warranties provided. Also, noncompete and nonsolicitation clauses may be important to secure the ongoing relationship and to protect from competitive forces. Indemnification and insurance provisions, including tail insurance requirements, are important features as in any acquisition agreement.

Hospitals considering divestitures are cautioned that legal issues abound. The Office of Inspector General is reportedly reviewing the anti-kickback implications of practice buy-backs. Stark issues should also be addressed and several Stark exceptions may have applicability to divestitures. An exception for isolated transactions may apply except in cases of installment sales. There is also a Stark exception for payments by physicians if the purchase is consistent with fair market value. The parties may want to consider the general fair market value exception described in the proposed Stark regulations.

The agreement should be drafted to fit within applicable anti-kickback safe harbors. Also, any covenant that has the direct or indirect result of channeling referrals may be problematic. While requiring medical staff membership may be acceptable, prohibiting participation on other medical staffs can raise serious legal issues.

An accurate valuation is essential. For a tax exempt entity, a determination of the fair market value of the practice will defend the transaction against assertions of private inurement or improper benefit. A valuation is also essential for avoiding Stark and anti-kickback difficulties. Accordingly, hospitals should obtain an independent valuation when selling a practice.

The negotiation process is critical to the success of the parties' ongoing relationship. Such negotiations can be very delicate given the tension between the desired ongoing relationship and the terms that will need to be negotiated. Negotiators may want to employ a "getting to yes" or similar approach as opposed to adversarial negotiations.

Continued Ongoing Relationships
While existing integration strategies have not met expectations, the benefits of integration remain a tantalizing possibility. Thus, a goal of a divestiture should be to find a means for continued meaningful integration. When divesting a practice, a hospital will want to simultaneously structure an ongoing relationship with the physician. These arrangements also offer the hospital the opportunity to assist the physician in easing back into private practice. Common examples include service arrangements, management contracts and leases. Recruitment assistance may also be possible thereby allowing the hospital to help the physician attract qualified assistants to build the practice.

Management agreements provide for a high degree of continued interaction. Such arrangements offer the physician the advantage of another party handling the day-to-day operations of the practice. Management relationships can be structured to meet a safe harbor and Stark exception.

Service contracts can also be an integral part of the ongoing relationship between the parties. A number of clinical requirements can be met through formal service contracts. On the other hand, such contracts must be very carefully drafted in order to avoid legal difficulties. Exceptions for personal service arrangements provide potential protection if all requirements are met.

Leases also present a means for ongoing interconnection between the parties. A physician may find a lease to be financially more desirable than purchasing the office. Thus, a lease may represent a means by which the hospital can provide a "soft landing" for the physician returning to private practice. Leases can be structured so as to fit within an applicable Stark exception as well as an anti-kickback safe harbor.

Recruitment assistance may provide a means for a hospital to indirectly assist a physician who has returned to private practice after a divestiture. Although regulatory exceptions exist for recruitment, the exceptions are not applicable unless the assistance is provided directly to the new recruited physician.