Recent Trends & Developments in Health Care Joint Ventures: Five Key Considerations for a Successful Joint Venture

On this second episode of Ropes & Gray’s Recent Trends & Developments in Health Care Joint Ventures podcast series, health care partners Devin Cohen and Ben Wilson discuss five key strategies to set up a health care joint venture for success. They talk about the important and everchanging regulatory requirements around these transactions, drafting tips, and key actions that stakeholders, principals, and businesspeople can take to ensure the success of their joint ventures

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Transcript:

Ben Wilson: Thank you for joining us today. My name is Ben Wilson—I’m a health care partner at Ropes & Gray. With me today is Devin Cohen, another partner in the health care practice group. This is the second episode in our series on health care joint ventures. Joint ventures are hot right now for several reasons. The health care world is still changing fast thanks to new technology, aging populations, and payment changes. Leading the way, or even keeping pace, will require cash and other resources. Meanwhile, markets are tough and interest rates are high, so teaming up with another organization is often the right play. But regulators are pushing back on traditional mergers and acquisitions. Joint ventures, however, have traditionally received less regulatory scrutiny. It’s no surprise, then, that joint ventures are becoming a popular way to partner. I will tell you, though, that in today’s world, being quick and efficient in planning and building out a joint venture can give you a big advantage. Those that move quickly grab opportunities that others miss. By having a plan and moving deliberately, you can avoid mistakes others will make. Most importantly, being quick and smart helps you build stronger and more successful relationships with your joint venture partners.

Devin Cohen: On today’s episode, we’ll focus on the five key factors to consider for joint ventures across stakeholders—hospitals, private equity sponsors, post-acute facilities, you name it. These are common themes across partnerships, and we’ll discuss practical action items in-house legal teams can focus on to get to “yes” and position the joint venture for success early:

• first, we’ll discuss identifying what outcome would be a “home run” for your organization;
• second, focusing on being targeted in diligence;
• third, ensuring clarity on what both parties are meaningfully bringing to the table and contributing to the venture;
• fourth, consulting with counsel to ID the long poles in the tent that can cause delays; and
• finally, moving fast but ensuring you’re doing so thoughtfully.

Identify and prioritize key goals of joint venture at the start.

Ben Wilson: Great, let’s dive in. First, really zero in on what a “win” looks like for everyone involved. Weirdly, people are pretty good at pointing out what the other side wants, but they have a much harder time figuring out what they want. If you can first get aligned on that internally, you can avoid getting bogged down later. Ever negotiated a deal and felt like you were lost in a maze, or felt like you were chasing moving targets with your team? Then, you know the issue that we’re talking about here. So, what can you do? Be sure that you can answer two simple questions.

First: What does this deal look like if it’s a home run for us? Unpacking that question means articulating your key goals, deal points, and milestones. Next (second question): What are the biggest roadblocks to actually pulling this off? This can unearth all sorts of constraints: time pressures, financial limitations, trust issues. Look, these sound totally obvious, I get it—and yet, almost nobody does it. Trust me, if you can make sure that everybody on the deal team can clearly answer those two questions, it will pay dividends throughout the deal.

Another point that people miss all the time with joint ventures: You need an executive sponsor—by that, I mean someone who makes the call and keeps everyone working towards addressing those two key questions. And hey, tactically, that executive sponsor really can’t be the CEO.

Devin Cohen: Yes, and so, you have an executive sponsor say, “We’ve identified your priorities and roadblocks.” It can seem extremely daunting to then take those big-ticket items and put them into a term sheet or an LOI, particularly since a number of key terms and the real “meat” of what you’d really expect in many instances are missing—but that’s okay. It’s for these reasons that so many LOIs are non-binding and focus primarily on exclusivity so the parties can then dig into diligence. The document’s really intended to set guardrails on what to expect in the next phase of discussions, but not to provide a laundry list of conditions and diligence items that need to be confirmed in order to move forward. Focus on the big-ticket items—these might be restrictive covenants, supermajority board or member approval requirements, capital contributions, put/call rights, even timing to close. Negotiate in broad strokes rather than getting bogged down in small details that can be developed during diligence—just be sure both parties are transparent on expectations of what issues they plan to dig into.

Conduct due diligence on partner EARLY.

Ben Wilson: Great points, Devin. And you hit on diligence—that leads directly into oursecond tip: You absolutely need to do due diligence on your joint venture partners, but keep it focused and wrap it up. While everybody knows diligence is necessary when you’re doing a mergers and acquisitions-type deal, people are sometimes surprised to hear you need to do diligence for joint ventures, too. Sorry to burst the bubble, but you do—diligence helps you to understand and manage regulatory, contractual, and reputational risks. Everybody hates diligence—that’s why I encourage you to be targeted and aim to rip the Band-Aid off quickly. The good news is that if you’ve followed step one and answered the two key questions we outlined—“What would make this a home run?” and “What are the likely roadblocks?”—it should be easy for you to build a prioritized and focused diligence request list.

Devin Cohen: Yes, and then, you can take that, and you can really keep the process moving quickly from there, building in protections for any issues that you identify during diligence into the joint venture agreement and the related documents. One of the biggest issues we see in diligence is when one party finds out the other one is already in a relationship with a different hospital or physician group, which might restrict its ability to enter into new partnerships. These can pose a few issues that will need to be navigated quickly but carefully. For example, your joint venture partner’s arrangement with another party probably has confidentiality restrictions, which may give pause to providing fulsome disclosures in diligence. Summaries or broad overviews, those may be permitted, but engaging with the other party’s counsel to brainstorm ways to work through these agreements early can be invaluable. Ultimately, though, the most efficient approach to be sure that your joint venture partner is able to move forward with you may be to push for direct conversations about carve-outs or new exceptions to existing restrictive covenants at the beginning. If not, what had been a two-party joint venture negotiation can really quickly develop into a three-party discussion when that other stakeholder demands a seat at the table.

Ensure both sides contribute something meaningful for joint venture.

Ben Wilson: Okay, third tip—this is a doozy. If your deal involves physicians or others that make or affect health care referrals—that’s ordering services, drugs, tests, etc.—do the fraud and abuse analysis early while you’re structuring the key parts of the deal. If you’re someone in a strategy or finance office, you’re going to need to get legal involved here. This gets hairy real fast. The analysis can change from deal to deal. Just because you’ve heard about somebody else doing something doesn’t mean they did it right or that it will work for you. Bottom line: You may learn that the business arrangements that make all the sense in the world and are common in any other industry are outright illegal in health care. If you’re in the legal office, I would strongly encourage you to pick up the phone and call us. There are lots of land mines here, but also some safe and tested paths—it helps to have a guide.

You need to think through what people will be contributing in exchange for a stake in the joint venture. As a general rule, ownership percentages and profit and loss sharing needs to be proportional to the fair market value of the contributions. And there are laws that restrict what you can count towards the contribution. You can’t, for example, get credit for contributing “referrals” or for the so-called “power of the pen.” There are other rules as well regarding what the government calls “suspect joint ventures”—basically, where someone in a position to refer gets to profit off a joint venture without proportional skin in the game. Ignoring these rules is a high-risk proposition. Besides the obvious risk of violating the law and incurring massive penalties, you might get months down the road with a joint venture just to have a lawyer or valuation expert throw up a red flag that forces you to go back to square one in negotiations.

Devin Cohen: Agreed entirely, Ben. There are a number of ways that these laws can come into play in joint ventures, and negotiations require vigilance throughout—you need to identify circumstances where physician referrals, payments, ownership interests, or services may be contemplated. And while a lot of these laws, like the federal Anti-Kickback Statute and False Claims Act, they require a nexus to Medicare, Medicaid, or similar federal health care programs, that’s not the case for all state laws governing fraud, waste, and abuse. Relatedly, the Stark Law may be implicated if a physician is put in a position to refer for certain classes of clinical services to an organization that he or she has a financial interest in. Now, Stark is a strict liability law, where intent does not matter, so ensuring that the joint venture is structured to account for relevant exceptions is of paramount importance.

Now, joint venture relationships and structures can implicate these laws across the board in a bunch of ways. For instance, will any physicians participate as owners of the joint venture, as Ben was discussing, and if so, will he or she be in a position to receive or make referrals? Relatedly, will any physicians provide medical director, consulting, or other types of services to the joint venture? Will either party or their affiliates provide professional services to support the venture’s ongoing operations—maybe even a space lease? Each of these questions could particularly implicate the federal Anti-Kickback Statute and Stark Law, and working closely with counsel early to make sure safeguards are embedded into the transaction structure can save a bunch of headaches down the line. We’ll be looking, in particular, to see if there’s any way to achieve the business goals while mitigating risk of fraud and abuse, often focusing on whether compensation is commercially reasonable, set and established at fair market value, and whether it’s in exchange for bona fide services. We’ll want to also be focusing on whether it takes into account the value or volume of the referrals between or amongst joint venture stakeholders.

Consult with counsel early about long pole regulatory hurdles that exist.

Ben Wilson: Great points. Fourth tip: While joint ventures might help you avoid some regulatory scrutiny, that doesn’t mean you won’t need approvals, or you won’t need to make regulatory filings. Getting legal involved early helps you in structuring around licensing, certification, and regulatory review requirements.

It’s worth noting these rules are also changing pretty quickly these days. There’s a whole set of new market oversight laws getting passed that allow state regulators to review material transactions. California, for example, has passed a new law that will require a bunch of health care joint ventures to go through a potentially lengthy review process starting next year. We have a separate podcast series that dives into those laws, which we’ll link to in the show notes. But why does this matter? It matters because states are clearly not looking to reduce the number of regulatory hurdles to joint ventures. For those pursuing joint ventures involving clinical affiliations or physician services, it’s worth noting that those are of particular interest to states as they are passing these new market oversight laws.

Devin Cohen: Right, so what are the types of approvals that keep joint venture partners up at night, and can be addressed strategically early? Sometimes, this may be through smart structuring—other times, proactive regulatory engagements or advocacy. Many of our listeners are familiar with the state Determination of Need and Certificate of Need requirements, with often six or more months for an application, a hearing, and approval for developing new health care facilities or acquiring new equipment. And that is where the state doesn’t have a moratorium on building out new hospitals or clinics in order to try to limit health care costs. Where joint ventures do contemplate new buildings or MRI machines, for example, you should still be sensitive to whether the relevant state will permit non-physician ownership, which has become a really hot button topic in some jurisdictions where partners want to build out substantial ambulatory surgery center models, for instance.

Even more routine updates to existing licenses for assets contributed to the joint venture, as well as new applications can take 60 or 90, sometimes, 120 days or more. You can get ahead of these issues that can cause delays early by effectively inventorying each regulatory submission required and putting on your advocacy hat to speak with regulators and encourage approvals as soon as possible.

Ben Wilson: Well said. And all that’s not to forget antitrust. Even for joint ventures, Hart-Scott-Rodino Act filings might be needed depending on the size of the transaction, among other things.  Substantive antitrust also matters here. Will the partners need to share competitively sensitive information? If so, how do you do that while staying under the antitrust speed limit? Will the joint venture contain restrictive covenants that might be viewed as anti-competitive? These are all things to think about with counsel while you’re sketching out terms.

Devin Cohen: Yes, and diligence findings identifying potential fraud and abuse risks could also impact the timing here, Ben. For instance, if the parties are considering contributing a wholly owned clinical asset, like a clinic, to their venture, and you’ve identified a potential Stark Law risk or a technical non-compliance, a self-disclosure may be required in order to close. Alternatively—and this happens often—when parties are in a sprint to close, the arrangement could be restructured so those clinic assets are made available to the joint venture via a services agreement, but all members of the joint venture are not on the hook for the pre-existing liabilities related to historical operations. So, that is, of course, something that can affect valuations and, ultimately, allocation of ownership interests, and is exactly the reason why it’s a strong option to consult early with knowledgeable counsel.

Move forward with deal expeditiously and amicably.

Ben Wilson: Okay, fifth and final point: Build in flexibility now for the joint venture to evolve over time. It’s a common mistake to think of joint ventures as being set in stone at closing. But even successful joint ventures tend to change and morph over time—it isn’t unusual for them to be totally restructured after a few years. So, what can you do about that now? A couple of things.

First, don’t make the terms of the joint venture impossible or impractical to modify. Again, you’ll think this is obvious until you start catching things in term sheets that do just this. Watch for terms requiring unanimous consent, for example. But you should also be proactive and flag terms that may need to flex over time. Consider expressly adding in a process around joint decision-making if you wouldn’t otherwise have one. For example, say your funds flow is tied to financial metrics that are based on projections. Projections are never right—it makes sense to build in a process to refresh those projections after a few years. Years from now, people will be so grateful if you spend some time providing a road map for making changes now, especially for those items that are predictable ones likely to change.

Devin Cohen: Exactly, Ben. And let’s be honest here—joint venture parties argue. Some of the best pre-planning that can be done is to provide a pathway for smooth resolution of those disputes. You want to create a dispute resolution process that’s practical and gets the right people into the room—and that’s not always involving the executive sponsor. While the dispute discussions may start with the sponsor at times, it often requires escalation ideally to pre-identified C-Suite executives to effectively settle the dispute. We want to avoid binding arbitration or potential suit at all costs here because we don’t want to strain the continuing relationship between the joint venture owners.

Ben Wilson: Great, and there you have it—five tips for a successful joint venture liftoff. Thank you all for joining us today. If you found our conversation enlightening, you won’t want to miss the rest of this podcast series—it’s a must-listen for anyone interested in health care partnerships. Subscribe now to stay informed and listen to other Ropes & Gray podcasts wherever you regularly listen to your podcasts, including Apple and Spotify. Thanks again for listening.