Why regulatory due diligence is essential in healthcare PE transactions  

By Jeffrey Mittleman and Jenna Schapiro, Holland & Knight

Your target is a physician or dental practice, an ambulatory surgery center, a medical device manufacturer, a pharmacy, a dialysis company, a durable medical equipment company or perhaps even a biotech or pharmaceutical manufacturer.

You have been eyeing a transaction in healthcare or life sciences and this one fits your investment criteria. You have executed a letter of intent and are ready for the due diligence process.

And you know the drill: hire corporate counsel to review all diligence materials and assess the potential risks associated with the proposed transaction – in particular, those matters that could subject you to successor liability.

In a non-healthcare deal, such risks might be tied to pending or threatened litigation, historical noncompliance with tax laws, or penalties that may be triggered under the target’s material contracts when the deal closes. But what about healthcare deals?

A buyer in a healthcare transaction must be cognizant of these same risks, in addition to a plethora of others that are regulatory in nature and specific to contractual arrangements in the healthcare arena.

While a strategic buyer would likely be familiar with such risks from its experience in day-to-day operations, a PE buyer, especially one that is new to the healthcare space, should take particular caution as it enters the market.

It should give special consideration in its due diligence review to the healthcare regulatory risks that may loom within the target’s historical operations.

While certain ownership structures and contractual arrangements are commonplace and perfectly permissible for non-healthcare entities, a PE buyer could find itself in hot water post-closing if regulatory authorities identify past noncompliance with healthcare laws.

Therefore, identifying healthcare regulatory issues during the due diligence phase of a transaction can greatly reduce the liability that a PE buyer takes on.

Contractual arrangements must be analyzed not only for their commercial terms but also to ensure that the compensation schemes, services rendered and other contractual terms comply with healthcare regulations and associated safe harbors and exceptions, where applicable.

In states that prohibit corporate practice of medicine or corporate practice of dentistry, as applicable, a PE buyer must take particular care to evaluate its target’s past and current ownership structure, as past noncompliance could result in successor liability.

Further, based on its review of the target’s past and current compliance with corporate-practice restrictions, a private equity buyer can best determine how to structure the pending transaction to maximize profits and minimize regulatory risks.

Aside from state corporate-practice doctrines, typical healthcare regulatory considerations to be analyzed during due diligence include the Stark Law, Anti-Kickback Statute, Civil Monetary Penalty Law, False Claims Act, HIPAA, and any applicable state counterparts.

Additionally, change of ownership and change of information filings often need to be made with state and federal regulatory agencies.

These include filings with Medicare and Medicaid, which is particularly significant from a buyer’s perspective, as the failure to make such filings in proper form and substance and in accordance with the required timelines could result in the inability to receive payments from these governmental payers post-closing.

The timing requirements surrounding these filings is essential, both to ensure continuity of reimbursement and to ensure the target is never practicing without a license (as state licensure requirements often include change of ownership provisions).

The penalties for a violation of state and federal licensure laws are often severe and can result in steep fines, criminal charges and license revocation. With the proper regulatory guidance, protective measures may be put in place to insulate a PE buyer from regulatory liability that may arise from a healthcare-related acquisition.

Jeffrey W. Mittleman and Jenna F. Schapiro are attorneys with Holland & Knight LLP. Mr. Mittlemann is a partner and co-leader of the healthcare and life-sciences industry group. He represents PE firms regarding investments in portfolio companies in healthcare and life sciences. Ms. Schapiro focuses on corporate and healthcare transactional matters, including M&A, joint ventures, PE deals and more. They can be reached at jeffrey.mittleman@hklaw.com and jenna.schapiro@hklaw.com.