And some more thoughts on BRMC

November 25th, 2010 | Income Approach & Methods | Noncompete Agreements | Regulatory Matters | Uncategorized

I have re-read the case for the fourth time and extracted some quotations for comment. I have also attempted to illuminate what Fair Market Value in a regulatory context means to an Appraiser and how the fundamental measure of an appropriate discount rate and measure of cashflows should (should) avoid much of the inherent issue of “valuing referrals.” (Note: Chapter 7 of theAHLA/BVR Guide to Healthcare Valuation, The Anti-Kickback Statute and Stark Law, looks at many of the issues discussed in this case, including noncompete agreements and Chapters 18 and 19 look at the mechanics of actually valuing a noncompete.

“Drs. Vaccaro and Saleh had a history of referring patients to BRMC for nuclear imaging until they invested in their own General Electric nuclear camera. With their own camera they no longer needed to refer patients to BRMC for imaging. BRMC threatened to revoke the doctors’ hospital privileges, which led to lengthy negotiations.”

(I think the above element of the fact pattern is one of the most damning. Although the Court does not mention it, fair market value includes a criterion that neither party is under duress.)

“Mr. [CPA] explained that his table is ?based on the assumption that the Physicians would likely refer this business to the Hospital in the absence of a financial interest in their own facilities or services, although they are not required to do so by virtue of any of the covenants contained in the Agreements or otherwise.”

“Therefore, the Report itself indicates that the analysis of whether the non-competition agreement represents a fair market value is based, in part, on anticipated referrals from the doctors. BRMC affirmed that the Report evaluated expected revenues based on the assumption that Defendants would likely refer the business to BRMC.”

And from the Deposition of the Hospital CEO:

“Q. It‘s fair to say that the purpose of the noncompete agreement was to protect that revenue stream [referrals from Dr. Saleh and Dr. Vaccaro].
A. The purpose of the noncompete, from my point of view, was to make sure that Drs. Vaccaro and Saleh didn‘t have a financial incentive to refer away from the hospital.
Q. Because if they didn‘t have a financial incentive to refer away, they would refer it to you?
A. We could hope that they would, yes.
Q. You did more than hope. You expected they would refer to you?
A. Expected they would refer a good bit of it to us, yeah.”

“A compensation arrangement does not take into account the volume or value of referrals or other business generated between the parties if the compensation is fixed in advance and will result in fair market value compensation, and the compensation does not vary over the term of the arrangement in any manner that takes into account referrals or other business generated.”

“While the value agreed upon by parties who are in a position to refer business to each other and who take into account anticipated referrals will be a fair value as between the parties, such an arrangement is not ?fair market value? under the Stark Act. Here, the compensation arrangement between the parties is greater than what would be paid in the absence of the ability of Dr. Saleh and Dr. Vaccaro to provide referrals for BRMC’s nuclear camera business.”

The Court concluded that the Defendant Hospital et al by their plain statements considered the volume or value of referrals. Notwithstanding that, the Court went on to say that even if that had not been the case, the Defendants could not rely upon the “fair market value” exception because the valuation itself expressly considered referrals.

Now, I would not be so foolhardy as to suggest that a different valuation model might have caused the Court to rule differently. However, assume for the sake of argument that none of the Defendants were on record as stating that they considered referrals when negotiating the arrangements. What type of assumptions might an appraiser have put into a valuation model that would not take into account the volume of value of referrals from the seller to the buyer to conform to the requirement that “‘General market value’ means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party” and “the definition itself differs depending on the type of transaction: leases or rentals of space and equipment cannot take into account the intended use of the rented item; and in cases where the lessor is in a position to refer to the lessee, the valuation cannot be adjusted or reflect the value of proximity or convenience to the lessor.” [emphasis added]

Before going to the Stark modifications of Fair Market Value it is important to note that the use of an appropriate equity discount rate and weighted average cost of capital is designed to account for the investment risk inherent in owning a business. One of the many differences between Fair Market Value and Strategic or Investment Value or Value to the [existing] Owner is the use of a market-based rate of return to discount future cashflows to present value. There is no discussion in the case about this at all. A Value to the Owner standard in the instant case might have resulted in the use of a risk-free rate, which in turn would have resulted in a much higher Value than if a market-based rate of return were utilized. At least from the standpoint of an Appraiser undertaking an exercise of determining Fair Market Value, the very use of a market-based rate of return will eliminate a significant portion of the value of “referrals” from the existing owners, because a hypothetical seller/buyer is substituted through the discount rate for the actual seller/buyer. The next part of the discussion focuses on the adjustment to the cashflows subject to discounting necessary to move from a Value to the Owner(s) standard to a Fair Market Standard that from an Appraisal standpoint does not consider referrals.

The subject Nuclear Medicine camera had been and remained post-transaction in the offices of the selling physicians for several years (through December of 2006, about three years). During that period of time, of course, most of the cases would come from the two selling physicians. It is not clear whether before or after the transaction any patients came from other physicians on the hospital staff, though in my mind that would clearly be relevant to the determination of Fair Market Value. In order to meet the requirement that “the valuation cannot be adjusted or reflect the value of proximity or convenience to the lessor” an Appraisal would merely look to what the rent on the piece of equipment might be – and that would already have been clear from the GE lease, which the Hospital assumed.

An Appraiser valuing a Nuclear Medicine Business – which is where a noncompete would become relevant – as opposed to a lease would have to base volume assumptions and resultant cashflows on what a freestanding Nuclear Camera owned, say, by an independent nonphysician vendor would expect to receive in referrals from the medical community assuming that the referring physicians had no financial interest in the Business. In a rural market like that of BRMC it is likely that before the physicians in the case acquired their Nuclear Camera, all of those cases had gone to the Hospital and there was no competing provider. This would make the task challenging, indeed, but I would think the assumption would be two market competitors, the Hospital and the Independent Vendor, and how that Independent Vendor might fare against the Hospital – and not giving effect to the Hospital’s threat to revoke the staff privileges of physicians who did not refer to it.

Note, as discussed elsewhere in my BLOG, a noncompete is part of the overall value of a business and represents the business that would be lost if the seller competed post-transaction, adjusted for the possibility that if allowed to compete, the seller would, in fact, do so, with the resultant cashflows discounted to present value at the discount rate used to determine the value of the business. This is referred to as the “with [the value with the noncompete in place] and without [the value without the noncompete in place] method.” A noncompete is not in addition to the value of the business. In the instant case, there appears from the record to be confusion between the value of a lease, the value of a noncompete and the value of a Nuclear Medicine business, among other things. Where that confusion originated is not clear.

One possible interpretation of the impact of the decision is that in circumstances such as this, the price paid for an operating business should be allocated to various component assets including the value of a noncompete to identify that portion of the value that is attributable to the sellers – assuming that noncompete value is based solely upon the sellers’ DHS referrals. Such an approach would require some thinking about the traditional model of noncompete valuation. The two steps discussed above – an appropriate return to a hypothetical; buyer/seller and identifying cashflows available to a market participant not in a position to refer – need first to be considered in the noncompete analysis. Then, the appraiser also has to ask him/herself how much business the buyer would lose if the sellers competed and what the likelihood of that competition is.

The larger question is whether an entire practice that owns DHS can be purchased with the valuation including the cashflows from DHS and the physicians then employed by the purchaser. As I indicated in an earlier post, it has been clear to many for some time that purchasing DHS separately from a purchase of an entire practice and leaving the DHS physically present in the still independent practice as if nothing had happened is a non-starter from the government’s standpoint.

It seems as well that a Hospital buyer should be first guided not only by qualified legal counsel but also by an opinion of Fair Market Value from an Appraiser with the requisite expertise to apply the regulatory standard to a valuation engagement before the Hospital embarks on discussing price with a physician-seller in a position to refer DHS. This is little different than retaining a neutral, subject to a Confidentiality Agreement, to evaluate financial terms in provider integration transactions subject to antitrust review before determining if a Memorandum of Understanding is appropriate to move forward. The lack of statutory authority for the OIG to opine on Fair Market Value is problematic and warrants extreme caution. Finally, threatening physicians in a position to refer with loss of staff privileges if they compete is not a good idea.

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