Definitions of Commercial Reasonableness and ACOs
(Part One of a Three-Part Series)

In response to the advent of Accountable Care Organizations (ACOs) and value-based reimbursement models, which focus on achieving better health outcomes at lower cost, hospitals are increasingly seeking closer relationships with physicians, including direct employment, co-management arrangements, and joint ventures.1 Corresponding with this growing trend toward hospital-physician alignment, there has been increased federal and state regulatory oversight regarding the legal permissibility of these arrangements. Most notably, there has been more intense regulatory scrutiny related to the Anti-Kickback Statute (AKS) and the Stark Law, especially as they relate to potential liability under the False Claims Act (FCA).2 As a result of this increased scrutiny, in fiscal year 2014, the U.S. Department of Justice (DOJ) opened 924 new criminal healthcare fraud investigations and 782 new civil healthcare fraud investigations, recovering $3.3 billion.3

The Medicare Shared Savings Program (MSSP), established as part of the Patient Protection and Affordable Care Act (ACA), created the first ACOs, and additional regulations have driven the evolution of ACOs since.4 ACOs consist of physicians, hospitals, and other healthcare providers who contract with a payor, and agree to be held to hold accountable for providing more efficient, quality services at a lower cost.5 ACOs accepted to participate in the MSSP, which is managed by the Centers for Medicare and Medicaid Services (CMS), may obtain incentives from the Medicare program for providing efficient, quality healthcare services, at lower costs. When ACOs are successful in reducing the cost of care and meeting certain quality care benchmarks, they benefit by sharing in the savings achieved by the Medicare program.6 CMS has established many ACO models, including: (1) the MSSP; (2) the ACO Investment Model; (3) the Pioneer ACO Model; and, (4) the Next Generation ACO Model.7 To encourage participation in the MSSP, CMS issued a number of fraud and abuse waivers through an interim final rule, which allowed providers to avoid potential liability under the Stark, the AKS, and the Civil Monetary Penalties (CMP) law.8 Most notably, the ACO Participation Waiver relieves MSSP participants from the AKS and Stark law requirements of proving fair market value (FMV) and commercial reasonableness.9 However, providers utilizing this waiver must meet strict guidelines to qualify and maintain the waiver protection, or they may be subject to liability under the fraud and abuse laws. CMS has issued extensions to the 2011 interim rule that established the MSSP waivers, but without a final rule to guarantee the continued permissibility of these waivers, the future of these waivers is uncertain.10 In addition to federal ACOs, there are also many commercial ACOs that share in other savings;
however, no waivers exist to protect these from fraud
and abuse liability.

Given the uncertain future of the Participation Waiver and the lack of a similar waiver for other federal and commercial ACOs, it is important for ACO participants to monitor their compensation arrangements to verify that they comply with the FMV and commercial reasonableness requirements of AKS and Stark. This three-part Health Capital Topics series will address the components of a defensible commercial reasonableness analysis and the importance of this analysis in
relation to ACOs.

For ACOs, it is critical to obtain and maintain appropriate documentation that any given physician compensation arrangement (whether it be for clinical services, administrative services, on-call services, or a combination of services) meets both the standard of FMV and the separate but related threshold of commercial reasonableness, in order to withstand regulatory scrutiny.  Typically, legal counsel does not provide opinions as to the commercial reasonableness of a compensation arrangement,11 and legal counsel will most often retain and rely upon an independent valuation consultant to provide a certified valuation opinion that the arrangement does not exceed FMV. Due to the increase in healthcare transactions in recent years,12 opinions related to the threshold of commercial reasonableness of healthcare transactions are becoming an “increasingly important service offered by healthcare valuation professionals.”13

Rendering a commercial reasonableness opinion requires that a specific set of core competencies be mastered by the valuation analyst apart from, but related to, the more traditional knowledge, skill set, and experience required in rendering FMV opinions related to the appraisal of the enterprises, assets and/or services being transacted. The key components of a commercial reasonableness analysis include both a consideration of the qualitative factors that affect the commercial reasonableness opinion, as well as a quantitative analysis of the elements of the anticipated transaction of the subject enterprise, asset or service.14

While definitions of the commercial reasonableness threshold are similar among the various federal agencies tasked with enforcing regulations affecting the healthcare industry, there are subtle nuances between each agency’s interpretation of the term “commercial reasonableness.” The Department of Health and Human Services (HHS) has interpreted the term “commercially reasonable” to mean an arrangement which appears to be “…a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.15 Additionally, HHS’s Stark II, Phase II commentary suggests that:

An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential DHS [designated health services] referrals.16

The Internal Revenue Service (IRS) and Office of the Inspector General (OIG) have also provided guidance in defining commercial reasonableness. IRS guidance regarding commercial reasonableness may be derived from IRS pronouncements on reasonable
compensation, including:

(1) The 1993 Exempt Organizations IRS text titled “Reasonable Compensation,” which states that “reasonable compensation is…the amount that would ordinarily be paid for like services by like organizations in
like circumstances;”17

(2) Chapter 2 of Publication 535, titled “Business Expenses,” which states “…reasonable pay is the amount that a similar business would pay for the same or similar services;”18 and,

(3)  Federal Regulations on “Excess Benefit Transactions,” which state, “reasonable compensation [is]…the amount that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances.”19

It should be noted that the IRS has not yet issued final guidance defining reasonable compensation specifically addressing the healthcare industry or ACOs.20 However, these factors provide indications as to the manner of assessing commercial reasonableness thresholds in an anticipated healthcare transaction.

Additionally, the OIG has defined a commercially reasonable transaction as one in which …the aggregate services contracted do not exceed those which are reasonably necessary to accomplish the commercially reasonable business purpose
of the service.”21

Further guidance indicating that, beyond the individual transaction elements, the entirety of a subject transaction should be reviewed in the aggregate (inclusive of all elements for which consideration is given) is found in the Personal Services exception of the Stark Law. This exception requires that “[t]he aggregate services contracted for do not exceed those that are reasonable and necessary for the legitimate business purposes of the arrangement(s).22

For transactions involving aggregate services, analysts must account for all elements of the integrated transaction in their commercial reasonableness opinions. Commonly referred to as a “wrap aroundcommercial reasonableness opinion, this type of analysis includes and considers all elements of the integration transaction in the aggregate, subsequent to the determination that each discrete, individual element of the transaction meets the thresholds of the standards of FMV and commercial reasonableness.  With complex acquisitions involving multiple property interests, a “wrap aroundcommercial reasonableness analysis provides a foundation upon which to establish and defend that the healthcare transaction is legally permissible and will withstand government scrutiny.

While the analysis of the threshold of commercial reasonableness is separate and distinct from the development of a FMV analysis, requiring consideration of different aspects of the property interest included in the transaction, they are related thresholds, and the consideration and analysis of one threshold does not preclude the analysis of the other threshold.  For example, a necessary condition for an anticipated transaction to be commercially reasonable is that each element of that transaction must not exceed FMV.  However, even in the event that each element of an anticipated transaction does not exceed FMV, the anticipated transaction may still not be commercially reasonable, in that it does not meet the remaining analytical hurdles of a commercial reasonableness analysis.  Consequently, a finding that an enterprise, asset or service meets the FMV threshold is not,
in and of itself, sufficient to establish
commercial reasonableness.23

A further distinction between a commercial reasonableness analysis and the development of a FMV opinion is that the commercial reasonableness thresholds include consideration of the “…value to the entity paying for…24 the enterprise, assets or services being transacted, while the FMV opinion requires that a universe of hypothetical buyers, sellers, owners and investors be considered.  For example, consider the acquisition of ten linear accelerators by a purchaser.  If the purchaser has need of only one linear accelerator, the purchase of ten linear accelerators even at a FMV price would not meet the necessity of the assets purchased threshold of the commercial
reasonableness analysis.25

Mastering the foundational principles for a commercial reasonableness analysis – including accurately understanding the definitions of commercial reasonableness, as well as the differences between an FMV opinion and a commercial reasonableness analysis – is essential before an analyst undertakes a commercial reasonableness analysis on behalf of an ACO client. In an era of increasing regulatory scrutiny and growing healthcare transaction volume, accurately grasping the nuances of commercial reasonableness definitions in relation to ACOs can improve the analyst’s understanding of the scope and objectives of a certified commercial reasonableness opinion regarding an ACO transaction. Further, properly applying these definitions within the qualitative and quantitative analyses can increase the defensibility of the opinion, thereby supporting efforts of healthcare providers to establish a defensible position that their proposed transaction is in compliance.

"2014 Global Health Care Outlook: Shared Challenges, Shared Opportunities" By Deloitte Touche Tohmatsu Limited, 2014, (Accessed 11/5/14) p. 13; "The 5 C's of 2013 Health Care" By Deloitte Touche Tohmatsu Limited, 2012, (Accessed 6/4/14); “Co-Management Arrangements: Common Issues with Development, Implementation and Valuation” By Ann S. Brandt, et al, American Health Lawyers Association, May 2011, (Accessed 6/5/14); “Top 10 Factors to Consider When Exploring Joint Ventures as an Affiliation Strategy” By Jonathan Spees, The Camden Group, June 2013, (Accessed 6/5/14).

"Health Care Fraud and Abuse Control Program: Annual Report for FY 2013" By The Department of Health and Human Services & The Department of Justice, Washington, DC, 2014, p. 6.

"Health Care Fraud and Abuse Control Program FY 2014" By The Department of Health and Human Services & The Department of Justice, Washington, DC, 2015, p. 1.

“Statutory Basis for the Shared Savings Program” CMS, August 27, 2015, (Accessed 8/28/15).

“Accountable Care Organizations: Value Metrics and Capital Formation” By Robert James Cimasi, MHA, ASA, FRICS, MCBA, AVA, CM&AA, Boca Raton, FL: Taylor & Francis, 2013, p. 2.

“Accountable Care Organizations (ACOs): General Information” CMS, August, 7, 2015, (Accessed 8/21/15).


““Medicare Program; Final Waivers in Connection with the Shared Savings Program” Federal Register Vol. 76, No. 212 (November 2, 2011) p. 67992.

Ibid, p. 68001, 68005.

“Medicare Program; Final Waivers in Connection with the Shared Savings Program; Continuation of Effectiveness and Extension of Timeline for Publication of Final Rule” Federal Register Vol. 79, No. 201 (October 17, 2014) p. 62357.

“Fair Market Value: Analysis and Tools to Comply With Stark and Anti-kickback Rules,” By: Robert A. Wade, Esq. and Marcie Rose Levine, Esq Audio Conference, HCPro, Inc., (March 19, 2008), p.49.

“The Health Care M&A Report: First Quarter 2015” By Irving Levin Associates, Inc., Norwalk, CT, 2015, p. 6.

“Healthcare Valuation: The Financial Appraisal of Enterprises, Assets, and Services” By Robert James Cimasi, MHA, ASA, FRICS, MCBA, CVA, CM&AA, Hoboken, New Jersey, John Wiley & Sons, Inc., 2014, p. 930.


“Medicare and Medicaid Programs: Physicians’ Referrals to Health Care Entities with which They Have Financial Relationships,” Federal Register, Vol. 63, No. 6 (January 9, 1998) p. 1700.

“Medicare Program: Physicians’ Referrals to Healthcare Entities with which They Have Financial Relationships (Phase II),” Federal Register, Vol. 69, No. 59 (March 26, 2004) p. 16093.

"Reasonable Compensation” By Jean Wright and Jay H. Rotz, Exempt Organizations Continuing Professional Education (1993), (Accessed 9/4/2012) p. 3.

"Publication 535 - Business Expenses", Internal Revenue Service, March 10, 2014, (Accessed 11/7/14) p. 7.

"Excess Benefit Transaction", 26 C.F.R. § 53.4958-4(b)(1)(ii) (2012).

“Internal Revenue Bulletin 2014-67: Private Business Use of Tax-Exempt Bond Financed Facilities” IRS, November 10, 2014, (Accessed 8/21/15).

“Subpart C: Permissive Exclusions – Exceptions” 42 C.F.R. § 1001.952 (2012).

“Exclusions from Medicare and Limitations on Medicare Payment” 42 C.F.R. § 411.357(d)(1)(iii) (2012).

Cimasi, Healthcare Valuation: The Financial Appraisal of Enterprises, Assets, and Services, 2014, p. 937-938.

“Medicare and State Health Care Programs: Fraud and Abuse: Clarifications of the Initial OIG Safe Harbor Provisions and Establishment of Additional Safe Harbor Provisions Under the Anti-Kickback Statue,” Federal Register, Vol. 64, No. 223 (November 19, 1999) p. 63526.

Cimasi, Healthcare Valuation: The Financial Appraisal of Enterprises, Assets, and Services, 2014, p. 938.

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