The Threshold of Commercial Reasonableness

In response to the advent of accountable care and value-based reimbursement, which emerging reimbursement models rely on for achieving better outcomes at lower cost, hospitals are increasingly seeking closer relationships with physicians, including direct employment, co-management, and joint ventures.1 Corresponding with this growing trend toward hospital-physician alignment, there has been increased federal, state, and local 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 In FY 2013, the U.S. Department of Justice (DOJ) opened 1,013 new criminal healthcare fraud investigations and 1,083 new civil healthcare fraud investigations, an increase from the 878 criminal healthcare fraud investigations and 776 civil healthcare fraud investigations opened in FY 2007.3

Valuation analysts should note that the fraud and abuse laws scrutinize many aspects of healthcare transactions, including physician compensation arrangements, under both the valuation standard of fair market value (FMV) and the separate, but related, threshold of “commercial reasonableness”.4  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 commercial reasonableness threshold in order to withstand regulatory scrutiny.  Typically, legal counsel does not provide opinions as to the commercial reasonableness of a compensation arrangement,5 and will most often retain and rely upon an independent valuation consultant to provide a certified valuation opinion that the arrangement does not exceed FMV and meets the requirements of commercial reasonableness. Due to the increase in healthcare transactions, notably from the first to second quarter of 2014,6 opinions related to the threshold of commercial reasonableness of healthcare transactions are becoming an “increasingly important service offered by healthcare valuation professionals.”7 This three-part Health Capital Topics series will address the components of a defensible commercial reasonableness analysis (CR analysis) and the importance of this analysis in today’s increasingly scrutinized healthcare marketplace.

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 CR 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.8 This first installment will address the definitions of commercial reasonableness and illuminate the subtle differences of commercial reasonableness definitions among federal regulatory bodies in order to provide indications as to the manner of assessing the factors and elements within the CR analysis.

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.9 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.10

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;”11

(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;”12 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.”13

It should be noted that no IRS pronouncement defining reasonable compensation specifically addresses the healthcare industry. 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.”14

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).15

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 around” CR 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 CR 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.16

A further distinction between a CR analysis and the development of a FMV opinion is that the commercial reasonableness thresholds include consideration of the “…value to the entity paying for…17 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.18

Mastering the foundational principles for a CR analysis – including accurately understanding the definitions of commercial reasonableness, as well as the differences between an FMV opinion and a CR analysis – is essential before an analyst undertakes a CR analysis on behalf of a client. In an era of increasing regulatory scrutiny and growing healthcare transaction volume, accurately grasping the nuances of commercial reasonableness definitions can improve the analyst’s understanding of the scope and objectives of a certified commercial reasonableness opinion regarding a particular 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, 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, To the United States Congress, Washington, DC, 2014, p. 6.

Ibid, p. 1.

“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. 938.

“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: Second Quarter 2014” By Irving Levin Associates, Inc., Norwalk, CT, 2014, p. 7-8.

Cimasi, 2014, p. 930.


“Medicare and Medicaid Programs: Physicians’ Referrals to Health Care Entities with which They Have Financial Relationships”, 63 Fed. Reg. 1700 (1/9/98).

“Medicare Program: Physicians’ Referrals to Healthcare Entities with which They Have Financial Relationships (Phase II)”, 69 Fed. Reg. 16093 (3/26/04).

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

"Publication 535 - Business Expenses", Internal Revenue Service, 3/10/14, p. 7,  (Accessed 11/7/14).

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

“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, 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”, 64 Federal Register 63526 (11/19/99).

Cimasi, 2014, p. 938.

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