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More Thoughts on BRMC

I have spent considerable time now studying the case (see post of 11/16). As those of us trained in tax law learn, court decisions are case-fact specific. Without seeing the valuation report cited in the decision, it is not possible to know precisely what was done, but it seems clear that in the Court's view, factors cited in the report were consistent with the purchase of referrals, e.g., ""These statements, however, do not counter the record evidence that the analysis in the [CPA Valuation] Report was "based on the assumption that the Physicians would likely refer this business to the Hospital" and that Mr. Leonhardt‘s summary presentation showed an expected profit for BRMC from entering into the lease agreement that was based on receiving business from V&S." This suggests - although again we cannot be certain - that the valuation had as an underlying assumption that all the Nuclear Scans done in the physicians' office would be referred post-transaction to the acquiring hospital. If so, this suggests to me strategic value. Given the requirement of the Stark regulations defining the modifications to fair market value, a compliant Fair Market Value analysis would have considered the risk of the Hospital (and other potential competitors) not receiving all of the referrals, to wit: 420 CFR 411.351 states “Fair market value means the value in arm’s-length transactions consistent with general market value. ‘General market value’ means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party; [emphasis added] And from Stark II-Phase 2: "“Moreover, the definition of ‘‘fair market value’’ in the statute and regulation is qualified in ways that do not necessarily comport with the usage of the term in standard valuation techniques and methodologies. For example, the methodology must exclude valuations where the parties to the transactions are at arm’s length but in a position to refer to one another. In addition, the definition itself differs depending on the type of transaction: leases or rentals of space and equipment cannot take into account the intended use of the rented item; and in cases where the lessor is in a position to refer to the lessee, the valuation cannot be adjusted or reflect the value of proximity or convenience to the lessor." [emphasis added] Thus the cashflow analysis and the discount rate developed in connection with such a valuation would have to reflect something other than the actual relationship between purchaser and seller. The Court clearly believed that the actual relationship was the basis for the valuation. And, it is not clear from the Court's opinion that the clear modifications to "fair market value" spelled out in the above two quotes from the Stark Regulations were taken into account. The OIG's office has long expressed concern with the sale of ancillary DHS owned by physicians to a Hospital or other buyer when the DHS will remain in the selling physician's office and continue to be used by the physicians. Although it involved a surgery center, similar issues in the OIG's perspective can be seen in Advisory Opinion No. 07-05. As I (http://cpa.net/?p=245) and other observers noted at the time, this Advisory seemed to misconstrue fair market value, while emphasizing the focus on referrals. http://oig.hhs.gov/fraud/docs/advisoryopinions/2007/AdvOpn07-05C.pdf

US v BRADFORD REGIONAL MEDICAL CENTER et al

In this newly released case involving a whistleblower on whose behalf the government had intervened, both parties moved for Summary Judgment. The case involved the sublease of a Nuclear Camera by two physicians on the BRMC staff who were threatened with loss of provileges for competing with BRMC in the provision of Nuclear Medicine scans. More importantly, a Valuation of a "noncompete" prepared by a CPA appears to be at the center of the case. "Before entering into a final sublease, BRMC had a "fair market value" assessment prepared by an accountant, REDACTED. (Leonhardt Dep. at 54; BRMC 30(b)(6) Dep. at 146-148.) BRMC sought this report to determine whether BRMC was paying fair market value under the proposed sublease arrangement. (Leonhardt Dep. at 54-55; BRMC 30(b)(6) Dep. at 148-149.) In September 2003, the Board of BRMC received Mr. REDACTED‘s report . The report concluded that the amounts to be paid pursuant to the proposed sublease were reasonable. (BRMC 30(b)(6) Dep. Appx., at 146-149.)" "In performing his fair market value analysis, Mr. REDACTED compared the revenues BRMC expected to generate with the sublease in place to the revenues BRMC expected to receive without the sublease in place. (Report of REDACTED, C.P.A.; Leonhardt Dep. at 55-56.) The projections were based on the expectation that V&S would refer such business to the hospital if the sublease arrangement was approved. (Id.) According to Defendants, the basis of Mr. REDACTED‘s report was what benefits BRMC would have lost had it terminated the medical staff appointment and clinical privileges of Drs. Vaccaro and Saleh pursuant to BRMC‘s Policy. BRMC advised Drs. Vaccaro and Saleh that its valuation expert indicated that he could support the fair market value of the Sublease, however neither Vaccaro nor Saleh received or reviewed a copy of Mr. REDACTED‘s written valuation." The decision is 69 pages long and well worth reading. In denying both parties cross-motions for Summary Judgment the Court concluded "Again, the record evidence is not strongly in favor of Defendants [BRMC et al] as it tends to show that Defendants entered into the Equipment Sublease fully aware that the arrangement, which had at its core a non-compete payment roughly equal to the referral business BRMC would gain from the doctors and the business V&S would lose from abandoning its own camera, may not be permitted under the Stark Act and Anti-Kickback Act. However, we are unable to conclude as a matter of law that Defendants acted ?knowingly? for purposes of the False Claims Act." "For the foregoing reasons, we will deny Defendants' motions for summary judgment, and grant in part, and deny in part, Relators' motion for summary judgment." http://docs.justia.com/cases/federal/district-courts/pennsylvania/pawdce/1:2004cv00186/3406/145/

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Valuing the Transaction and Strategic Value?

At yesterday’s session on Cost of Capital with Carol Carden at the BV Conference, one of my colleagues raised the question from the floor about whether “valuing the transaction” in healthcare constitutes strategic value. It clearly does not.  Among the many aspects of the healthcare industry is the regulatory construct which requires fair market value as a standard in all valuation engagements.  Therefore, one of the things that an appraiser must learn in practicing in the healthcare industry is how to apply the FMV standard of value to valuation models where someone unfamiliar with the regulatory construct might inadvertently develop strategic value – or, for fear of developing strategic value, default to valuing some “hypothetical” transaction. 

 “Terms Make the Deal” is a common cliché’ in transactions but it is not an indicia of strategic value.  As a simple example, consider the value of a noncompete agreement as part of the enterprise value of a given medical practice.  Assume that the seller has the ability and intent to compete post-transaction absent a contractual provision precluding that competition.  A Hypothetical Buyer would pay less for the business – if pay anything at all – absent the noncompete, while a hypothetical seller expects to be paid for not competing in addition to being paid for the value of the other assets being sold.  Thus, the noncompete has an identifiable value - that can be determined through a “with and without” analysis – and two different Fair Market Value prices would be determined for the Enterprise based upon the Terms of the Deal.  The question is not whether the presence or lack of a covenant presents Strategic Value – it does not – the question is what Hypothetical Buyer and Seller would reach as a purchase price for the business with and without the noncompete.

 The discussion cannot stop there. The Terms of the Noncompete itself determine its value.  Thus, a noncompete with a geographic restriction of 10 miles might be expected to have a value less than one with a geographic restriction of 25 miles, assuming that the catchment area of the medical practice extended beyond 10 miles.  The sale of the practice with a 10 mile noncompete provision versus one with a 25 mile noncompete provision would have two Different Fair Market Values! Nothing about the geographic range of the noncompete term represents strategic value so long as the Appraiser focuses his or her attention on what a Hypothetical Buyer and Seller would agree to as a transaction price.

 As I responded in yesterday’s session, Appraisers need to focus on what actual assets are being transferred.  One of the important lessons learned from the literature on FAS 141/142 and the focus on valuing the left – Asset - side of the Valuation Equation is that the Market Value of Invested Capital is the aggregate of the Assets of the Business.  If the Transaction Documents pull out certain of those assets – like Accounts Receivable net of payables, for example, which is a common exclusion in a medical practice sale – a Hypothetical Buyer and Seller would and in fact must adjust the actual Transaction Price, notwithstanding any conclusion of MVIC – or, risk regulatory review due to paying for something you did not receive, a primary indicator that a prohibited buying-of-referrals motive was present.

 As I further stated several times during the presentation, the 2008 Tax Court Case Derby makes it very clear that the Appraiser must – read that must – review the actual transaction documents specifically with respect to the post-transaction compensation and terms of the noncompete in order to determine the value of what was transferred.  If the actual documents are not available, key assumptions such as post-transaction comp and noncompete terms must be obtained from the client and they should be 1) specified in the Report and 2) considered for a Representation Letter. This is a left-hand side or Asset approach to valuing transaction in contrast to the simpler, default right-hand or Invested Capital Approach.  Assets have a Fair Market Value just as does Invested Capital and due to the Terms of the Deal, the two may not always be equivalent because either 1) some element of the Invested Capital is not transferred like working capital or 2) the terms of the transaction transfer more or less value that what the Appraiser’s generic concept of the transaction might be, such as a noncompete with a 10 versus 25 mile radius.

 In healthcare transaction we encounter these nuances more often than not. We are expected under the regulatory standard of practice to assign value to these nuances, otherwise the transacting parties and the Appraiser risk civil or criminal prosecution. 

 As a final thought, real estate appraisal and transaction are no different!  If a hypothetical buyer makes an offer on a home and the Building Inspection determines that the heating system is about to fail and will cost $10,000 to replace, one expects that the Hypothetical Buyer and Seller will make an adjustment to the Offer Price – or else a transaction will not take place.  Simpler still, if there are two otherwise identical 4 bedroom homes located in the same neighborhood and one has been recently renovated with new kitchen cabinets, bathroom fixtures and a deck and the other requires updating, they will have two different prices.  The reason is that the condition of the underlying component assets being transferred differs!  The utility and the present value of expected future outlays by the owner to maintain House 2 are greater than House 1 making House 1 more valuable today!

 Don’t fall victim to the tired argument that valuing the actual assets transferred in a transaction somehow constitutes strategic value.  Only the Fool of Circus-man PT Barnum’s famous adage would pay $10 for a $5 bill.