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The healthcare sector has undergone tremendous disruption and change over the last several years, putting significant strain on the bottom line at many hospitals and healthcare providers. A seemingly perfect storm of evolving patient expectations, tightening budgets, shifting reimbursement models, and regulatory reform at state and national levels is driving trustees and other decision makers to consider severe measures to maintain financial viability in an increasingly competitive market.

These tremendous financial pressures were only exacerbated by the global COVID-19 pandemic. The unprecedented challenges created by the pandemic have served to accelerate many of the issues healthcare providers have been working to address. Facilities with already tight operating margins have had to temporarily eliminate elective procedures and have seen a decrease in emergency department visits, reducing volume and revenue. Now, as volumes begin to increase, patients may be sicker and face additional complications after delaying care. In addition, economic volatility may have impacted investment performance and sources of income that hospitals may have used to cover COVID-19 and other operating losses. All of these short-term realities of COVID-19 will have a lasting impact for many facilities and throughout the industry.

A hospital board of trustees has a unique role to play in navigating these issues and considering a wide range of stakeholders in guiding the hospital or healthcare system to the best possible outcome. The board has a fiduciary responsibility to ensure these challenges are resolved in a fiscally responsible manner while ensuring that any transition effectively serves patients and the broader community. This often involves close collaboration between trustees and a hospital’s day-to-day leadership, which can help to gain buy-in and create a smooth process for decisions that ultimately require board approval.

For Some Facilities, M&A is Off the Table

Trustees and hospital leaders have been looking to mergers, acquisitions, and other partnerships as a relief valve for these mounting financial pressures. This has driven unprecedented M&A activity in the healthcare space over the last few years, with 92 transactions last year alone. COVID-19 has had a significant impact on this front as well. Many would-be partners have stopped or slowed transactions amid the tremendous uncertainty caused by the pandemic. COVID-19’s ultimate impact on M&A activity is unknown. In the short term, however, it is clear that there is a greater reluctance to finalize deals until the true financial implications of the pandemic are better understood.

Whatever the cause, trustees and leadership of failing hospitals and health systems, who have exhausted ordinary cost-cutting measures and cannot identify a buyer or partner, need to understand and evaluate their other options. Bankruptcy is one scenario for these facilities, which presents its own unique set of challenges and considerations. For facilities that are not pursuing bankruptcy, the alternative options fall into two broad categories. The first is to eliminate or downgrade services that are no longer financially viable. Some hospitals and health systems are exploring transitions such as ceasing to provide inpatient services in favor of solely providing outpatient services. In other instances, healthcare facilities are shutting down specific lines of services, such as obstetrics and gynecology, that have become a financial strain amid industry shifts. The second, more drastic option is to close the facility entirely. There is considerable overlap in the steps required in each undertaking. In either case, successful execution depends on navigating the applicable regulatory, legal and contractual hurdles.

Begin with Effective Due Diligence

Whether jettisoning services or shuttering the facility altogether, a critical first step for trustees and C-suite leaders is to gain a comprehensive understanding of the full scope of the work that will be required. That framework can then be used to create a detailed plan that can be shared with regulators and guide the course of action.

Each state has specific requirements for notifying its department of health with details of a closure plan, including specifying when a facility will stop accepting new patients, protocols for transferring patients, and other key details. In instances where a hospital or health system is transitioning away from certain services, such as moving exclusively to outpatient services, trustees and operators need to be conscious of the licensing changes that such a downgrade may trigger. Shifting services may require new or amended licenses. At the federal level, a change in operations may require specific change of information updates with Centers for Medicare and Medicaid Services.

For systems undergoing a transition or closing, there are other considerations related to the facility’s stated corporate purpose and potential legal and contractual obligations. A nonprofit healthcare organization, for instance, may need to follow certain protocols with the state attorney general when conveying assets, as well as consider potential restrictions around how donations or remaining endowment funds can be used. A nonprofit hospital with an endowment centered on inpatient services, for instance, may face additional complications in making the switch to an outpatient-only provider.

Similarly, bond covenants may stipulate specific uses that are tied to the investment. In these cases, downgrading services may trigger a defeasance or require working with underwriters and bond holders to amend applicable loan agreements.

Ensure Compliance with Department of Labor Requirements

Closing an entire facility, and in many cases ending specific services, will often trigger reporting and employee notification requirements under the Worker Adjustment and Retraining Notification (WARN) Act. Companies that employ more than 100 full-time workers are subject to the Act and must provide at least 60 days advance notice under the following circumstances:

  • Closing a facility or discontinuing an operating unit permanently or temporarily, affecting at least 50 employees during any 30-day period, not counting part-time workers, at a single site of employment;
  • Laying off 500 or more workers (not counting part-time workers) at a single site of employment during any 30-day period; or
  • Laying off 50-499 workers (not counting part-time workers) during any 30-day period, and these layoffs constitute 33% of the employer’s total active workforce.

Consider All Facility Agreements and Vendor Contracts

Ultimately, trustees and leadership must ensure all aspects of a facility’s operations are included in a robust transition or closure plan. This is the only effective way to accurately quantify the financial implications of any action and make the most prudent decision. It is critical that any analysis includes a comprehensive overview of agreements and ongoing responsibilities, from software vendor contracts to physician contracts, union agreements and more. Certain agreements may contain penalties for early termination that may severely impact any transition or closure plan.

Establish an Effective Timeline

Many state and federal rules require at least 60-days’ notice for terminating operating licenses, notifying employees and other regulatory agencies. Best practice illustrates that it often requires considerably more time to effectively execute a healthcare facility closure or significant transition of services. Trustees and other hospital leaders should allow for at least six months to plan and execute these significant undertakings. If they foresee the government getting involved to attempt to prevent a location from closing or attempting to dictate the terms of a transition, the process can be expected to take even longer.

This timeline should also consider requirements and potential costs after the closure of the facility or line of service. Key areas of focus should be on recordkeeping and patient notification. The Medicare conditions of participation for hospitals require retention of medical records for at least five years. State laws may require that records be maintained for a greater time period. For example, Pennsylvania requires that hospitals maintain records for seven years following discharge for adults, and for seven years beyond age of maturity for children. In cases of a hospital closure, Pennsylvania requires that records be kept for at least five years after the closure date.  State laws in other jurisdictions may contain different mandates. Maintaining these records or establishing a custodian and notifying patients are additional costs that trustees and other hospital leaders should consider as they navigate a closure plan.

The Importance of Knowledge and Experience Cannot be Overstated

It can clearly be seen just how complex any downgrade in services or healthcare facility closing can become. Every detail is critical, and without an effective plan and execution, these undertakings can be derailed, creating even greater financial strain on the organization and placing its future into greater uncertainty. That is why it is so critical to retain legal counsel with a specific focus in healthcare industry operations and transitions. The value they provide with regard to regulatory compliance and making sure no element is overlooked or misjudged can help ensure the transition or closing occurs in a timely, predictable manner that satisfies the needs of trustees, leadership and all stakeholders.

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

Healthcare M&A: Legal Considerations of Hospitals and Health Systems Considering Chapter 11 Bankruptcy

Healthcare M&A: Negotiating and Papering Key Aspects of a Deal

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.