Due to the heightened legal and regulatory scrutiny of healthcare related transactions, the issuance of Commercial Reasonableness opinions is a growing area of focus for professional advisors and consultants in the healthcare industry. Note that, the threshold of Commercial Reasonableness is separate and distinct from the threshold of Fair Market Value, and the consideration and analysis of one threshold does not preclude the analysis of the other threshold. For example, a necessary condition in order for an anticipated transaction to be Commercially Reasonable is that each element of the transaction must not exceed Fair Market Value. However, even in the event that each element of an anticipated transaction does not exceed Fair Market Value, the transaction may still be deemed not to be Commercially Reasonable, in that it does not meet the remaining qualitative and quantitative hurdles.
Commercial Reasonableness opinions are informed by the evolving guidance derived from healthcare related statutes, rules, and regulatory pronouncements, as well as some minimal indications, to date, from pertinent case law. For example, the Department of Health and Human Services (HHS) has interpreted the term “commercially reasonable” to mean that an arrangement appears to be:
“…a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.”1
Also, the Stark II, Phase II commentary also 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 referrals”. 2
In addition, commentary published by the 2006 American Law Institute suggests that,
“Each financial and contractual connection between hospitals and physicians should be scrutinized to ensure that goods or services changing hands are being provided at fair market value, and at a level no more than necessary for the business purposes of the arrangement”. 3
Commercial Reasonableness Defined
Currently, there is no single, universally accepted definition of Commercial Reasonableness, and additional guidance for its interpretation can be gleaned from: the Internal Revenue Code (IRC), Treasury Regulations, other IRS publications and pronouncements related to reasonable compensation; OIG Advisory Opinions and pronouncements; Anti-Kickback Regulations; the US Public Health Code; and, pertinent case law.
Health Capital Consultants (HCC) has formulated a disciplined and robust process that assesses both the qualitative and the quantitative elements of a transaction in assessing its Commercial Reasonableness.
The qualitative assessment related to the commercial reasonableness of an integration transaction includes deriving answers to the following:
- Is the transaction a sensible, prudent business agreement even in the absence of referrals;
- Is the integration transaction necessary to accomplish the business purpose of the client;
- Does the nature and scope of the underlying elements of the integration transaction meet the business needs of the client;
- Does the enterprise and organizational elements of the integration transaction make business sense to the client;
- Does the quality, comparability, and availability of the underlying elements of the integration transaction make business sense for the client; and,
- Are there sufficient ongoing assessments, management controls, and other compliance measures in place related to the underlying elements of the integration transaction.
In assessing the Commercial Reasonableness of an integration transaction from a quantitative perspective, which is commonly referred to as a post-transaction financial feasibility analysis, the following analytical techniques may be used:
- Payback Period or Discounted Payback Period Analysis;
- Net Present Value Analysis; or,
- Internal Rate of Return.
- “Medicare and Medicaid Programs; Physicians’ Referrals to Health Care Entities With Which They Have Financial Relationships” Fed. Reg. Vol. 63, No. 6, (Jan. 9, 1998), p.1700.
- “Medicare Program; Physicians’ Referrals to Health Care Entities With Which They Have Financial Relationships (Phase II)” Fed. Reg. Vol. 69, No. 59, (March 26, 2004), p.16107.
- “Healthcare Joint Ventures,” By Alson R. Martin, American Law Institute, SM047 ALI-ABA 1093 (2006).