Outsourcing Hospital Departments: Strategies for Success. Thomas E. Bartrum, Esq. 1

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1 In-House Counsel Program - June 24, 2007 Outsourcing Hospital Departments: Strategies for Success I. The Prevalence of Hospital Outsourcing Thomas E. Bartrum, Esq. 1 A. Historically, hospital outsourcing has been limited to support services (e.g., housekeeping, laundry, food services, etc.) and non-core patient care services (e.g., rehabilitation, psychiatric, wound care, therapy services, laboratory, perfusion, pharmacy, etc.). B. In the late 1980s and 1990s, hospitals began to supplement patient care services historically performed by house staff and contracted attorneys to proprietary management and physician staffing companies. This business model has been most successful in the context of physician staffing of emergency departments. C. Like many other industries, hospitals now actually engage in outsourcing IT and other non-core, business support services to specialist providers. Such services include training, supply chain management, human resources, billing and collections, revenue cycle management, etc. Hospitals may also consider outsourcing business services unique to health care such as its electronic medical record development and maintenance, PACs, RIS, clinical trials, etc. Although some of the general concepts discussed herein apply equally to these non-patient care outsourcing arrangements, such arrangements are not the topic of this outline and will not be further discussed herein. D. Today, we are seeing a number of patient care services traditionally furnished by the hospital being outsourced to other clinical service providers. Such arrangements may take the form of outsourcing agreements, service agreements, service line management agreements or under arrangement agreements. 1. In a 2006 survey of hospital executives, 78% of respondents currently outsource at lease one patient care service. Waller Lansden Dortch & Davis, LLP, 2006 Hospital Outsourcing Trends in Clinical Services Survey (the 2006 WLDD Survey ). 2. The 2006 WLDD Survey found that the following ten patient care services are most likely outsourced: a. Dialysis (31%); b. Sleep disorders (24%); 1 I want to thank my former law firm, Waller Lansden Dortch & Davis, LLP, for its support of me in grappling with these issues, providing me the opportunity to present on these issues today, and having the vision and leadership in looking behind the curtain to discover what services hospitals are currently outsourcing by means of Waller Lansden s 2006 Hospital Outsourcing Trends in Clinical Services Survey. Further, special acknowledgement and thanks goes to my former partners, Reggie Hill and Bobby Guy, who graciously allowed me to use materials that were prepared by Waller Lansden Dortch & Davis, LLP and constantly remind me that we, as health care lawyers, are truly blessed by having colleagues that unselfishly share their expertise, experience and time. Of course, any mistakes, errors and general blunders remain sole mine.

2 c. Diagnostic Imaging (23%); d. Laboratory Services (20%); e. Physical Therapy (18%); f. Hospitalists (17%); g. Specialty Equipment (17%); h. Rehabilitation Services (14%); i. Hospice care (13%); and j. Wound care (13%). 3. Interestingly, the 2006 WLDD Survey found that larger hospitals and health systems (i.e., 200 beds or greater) are more likely to outsource patient care services (86% of respondents currently outsource patient care services) than small hospitals (i.e., less than 50 beds) (68% of respondents currently outsource patient care services). Such a result is surprising in that conventional wisdom was that smaller hospitals outsourced more patient care services because of a lack of specialized management expertise, lack of physicians, and the offset the cost of expensive, new equipment. II. Why Would a Hospital Outsource Health Care Services? A. Most outsourcing decisions are driven by three factors: reduced costs, improved processes and the ability to focus on core businesses. However, other factors come into play also (especially in the health care context) such as expertise of the service provider, revenue enhancement, access to capital, quality, commitment to compliance, trust and cultural fit with management. B. The 2006 WLDD Survey respondents indicated that they chose to outsource a particular patient care service because: expertise of the vendor (55%); cost savings (23%); add a new service line (21%); revenue enhancement (18%); request by physicians (17%); access to capital (8%); other (13%). C. A few insights into the 2006 WLDD Survey suggest drivers for patient care outsourcing may also be: 1. The need for specialized knowledge or equipment to deliver the service; 2. Reimbursement concerns/opportunities; 3. Develop new service line though joint venture with physicians or management company; 4. Continue utilization of established vendors of specialized services (e.g., rehabilitation services);

3 5. Overall industry segment activity (e.g., imaging services); and 6. Favorable treatment of the service under the Stark law. These issues are discussed in more detail in Attachment B Additional Analysis of 2006 Hospital Outsourcing Trends in Clinical Services Survey Data III. Common Means of Outsourcing Hospital Clinical Services A. For purposes of the 2006 WLDD Survey, patient care outsourcing arrangements were divided into three basic categories: 1. True joint ventures whereby the hospital joint ventures the service and the profits are split among the joint venture participants ( Joint Ventures ). 2. Contractual arrangements whereby the hospital contracts with the vendor of the service and the vender of the service retains residual profits associated with providing the service ( Contractual Arrangements ). In such instances, the service provider would typically bill for the service itself; however, in some instances, it may be possible to structure so that the hospital bills for the service and the residual profits are paid out to the service provider pursuant to the contract. 3. Agreements with the outside vendors where the profits are retained by the hospital ( Outside Vendor Agreement ). These arrangements are typically the least integrated in that the service provider may be simply providing a service for a fixed fee or providing management services for a department of the hospital. However, because it may be possible to incentive the outside vendor s performance, these arrangements are also treated as patient care outsourcing arrangements for purposes of this outline. B. Unfortunately, real life rarely fits into such nice categories and we see a number of these types of agreements that attributes of one or more models. C. The 2006 WLDD Survey found that the following structure breakdown among specific patient care services outsourced: Patient Care Service Joint Venture (profits to the JV) Contractual Arrangement (profits retained by Vendor) Outside Vendor Agreement (profits retained Hospital) by Dialysis Services 11% 50% 39% Sleep Disorders 28% 15% 56% Diagnostic Imaging 26% 37% 37%

4 Patient Care Service Joint Venture (profits to the JV) Contractual Arrangement (profits retained by Vendor) Outside Vendor Agreement (profits retained Hospital) by Laboratory Services 19% 42% 40% Physical Therapy 21% 23% 56% Specialty Equipment 10% 29% 60% Hospitalists 6% 67% 27% Rehabilitation Services 13% 21% 66% Hospice Care 26% 51% 23% Wound Care 23% 29% 49% Cancer Center 42% 27% 30% Behavioral Health 11% 37% 52% Outpatient Surgery 81% 15% 4% LTAC 32% 42% 26% Bariatric Surgery 58% 25% 17% Geriatrics 50% 33% 17% Other 6% 31% 63% IV. The Dynamics of a Typical Outsourcing Arrangement A. Structure:

5 Exclusive Contract Staffing Company Hospital $ $ Independent Contractor Agreement $ $ Submits Claim for Facility Services Payor Submits Claims for Physician Services Physician B. Deal Overview: 1. Hospital wants to relieve itself of the burden of ensuring physician coverage of the Emergency Department ( ED ). 2. Hospital will outsource physician staffing and scheduling of ED to outsource provider. 3. Outsource provider will employ/contract with ED physicians and bill for professional services furnished by the ED physicians and retain such revenue. It is not unusual for the outsource provider to also undertake certain administrative and management tasks associated with the ED, including appointing a medical director. The staffing requirements may of the outsource provider may also include mid-level, non-physician practitioners (generally, Physician Assistants and Nurse Practitioners). 4. Depending upon the project utilization and payor mix of the ED, outsource provider may require hospital to pay a subsidy to the outsource provider. Such subsidy could be structured as a flat fee arrangement, a per patient fee, or a revenue or collections guarantee. The entire outlay by the hospital may be subject to a ceiling. Often the ceiling is tied to the number of ED patient visits for the year. 5. Often the outsource provider is charged with assessing operations and optimizing patient flow so as to decrease time to see a physician, decrease the number of patients leaving without being seen, improve patient satisfaction, decrease diversion and ED overcrowding, and improve physician and hospital ED revenues. C. Key Negotiation Points (Historically): 1. The hospital s costs assuming that the arrangement contemplates a subsidy to be paid to the outsource provider. 2. The term of the agreement with the hospital desiring the ability to walk away easily in the event that the relationship does not work. Typically, the hospital will have the ability to terminate without cause upon a relatively short notice.

6 3. The outsource provider will often want non-compete and non-solicitation provisions to protect the intellectual capital that it is bringing brought by the outsource provider. As discussed below, these should typically be avoided by hospitals. 4. A requirement that the outsource provider has malpractice insurance and V. The PhyAmerica Case A. A summary of the PhyAmerica case is attached hereto as Attachment C. B. The key points are: 1. Despite the fact that many of the PhyAmerica contracts contained without cause termination provisions that would allow the hospital to terminate upon 90 or 120 days prior notice, the bankruptcy court refused to allow hospitals to exercise such terminate rights without relief from the automatic bankruptcy stay. Hence, the 90 or 120 day contracts became long term obligations of the hospital. 2. In many instances, PhyAmerica was unable to pay physicians on a timely basis. Some hospitals were forced with making payments to ED physicians to avoid walk outs and then becoming a creditor in bankruptcy to PhyAmerica. Note, however, that these contracts did not specifically require PhyAmerica to pay the ED physicians staffing the hospital 3. Standard contract language regarding automatic termination in the event of the filing of bankruptcy is largely unenforceable under bankruptcy laws. 4. PhyAmerica s malpractice insurance prior to bankruptcy provided hospitals with additional insured status so that hospitals were entitled to coverage to the extent that PhyAmerica had insurance coverage. As the case developed, however, it became apparent that such insurance coverage was inadequate and under funded. The bankruptcy plan was to sell PhyAmerica s assets, including the hospital contracts, to the highest bidder. Upon objection by several hospitals, the plan was amended to clearly provide that their rights to insurance coverage would be assured upon such sale. Nonetheless, because of disputes over the sales agreement, the eventual purchaser of PhyAmerica s assets sought to limit the number of malpractice claims against the insurance. In 2005, the court issued a judgment action that granted hospitals continuing rights to protection under existing insurance policies and future polices to be purchased by the purchaser. Despite this victory, it appears that the initial policy proceeds available to cover claims against hospitals and physicians may be only $60,000 per claim. VI. Lessons Learned from PhyAmerica A. An At-Will Termination Clause May Be Inadequate Protection for the Hospital. B. Automatic Termination Upon Filing of Bankruptcy Largely Unenforceable. C. The Contract Should Specifically Obligate the Outsource Provider to Pay Physicians and others staffing the Hospital.

7 D. Insurance Coverage is Not Enough The Hospital Must Judge The Insurance Company And Receive Notices From The Insurance Company Of Any Changes In The Policies (Which Should Trigger Termination Rights). VII. Other Potential Legal & Business Concerns with Outsourcing Hospital Clinical Services. A. Who will bill for the service? 1. Hospital Bills for the Service. a. Can the service be furnished by the hospital under arrangement? (i) Medicare allows hospitals (and certain other providers) to obtain certain services under arrangement. That is, instead of the furnishing the service directly, the hospital can contractually obtain the service from another. The hospital, however, generally bills for the service and is paid as if the service was furnished directly by the hospital. Medicare Claims Processing Manual (Pub ), Chapter 1, Medicare allows providers other than hospitals to obtain services under arrangement, including critical care hospitals, skilled nursing facilities, home health agencies, and hospice providers. 42 U.S.C. 1395x(w)(1). (ii) Technically, a service is obtained under arrangement only when receipt of payment by the hospital discharges the liability of the beneficiary or any other person to pay for the service. A provider obtaining services under arrangement cannot merely act as a billing agent for the under arrangement service provider. Instead, the provider must exercise professional responsibility for the service obtained under arrangement. Such professional responsibility requires that the hospital: (a) Apply the same quality controls over the under arrangements personnel that it would over its own employees; (b) Apply its standard admission policies; (c) Maintain a complete and timely clinical record on the patient, including diagnoses, medical history, physician s orders, and progress notes; entity s attending physician; and (d) Maintain liaison with the under arrangement (e) Ensure that the medical necessity of the services is reviewed on a sample basis. Medicare General Information, Eligibility and Entitlement Manual (Pub ), Chapter 5, 10.3; see also HCFA Administrative Bulletin #1347 (Apr. 10, 1979). (iii) CMS has said that the purpose of under arrangement authority is to provide a means for hospitals to obtain specialized healthcare services that it does not itself offer, and that are needed to supplement the range of services that the provider does offer its patients. 67 Fed. Reg. at (Aug. 1, 2002).

8 (iv) to be furnished under arrangement: CMS specifically authorizes the following hospital services (a) Hospital Inpatient Services: (1) Medicare covers such other diagnostic or therapeutic items or services, furnished by the hospital or by others under arrangements with them made by the hospital, as ordinarily furnished to inpatients either by such hospital or by others under arrangements. 42 U.S.C. 1395x(b)(3). (2) The Medicare Act clearly provides that the following hospital inpatient items or services cannot be obtained under arrangement : i) Bed and board; and ii) such nursing services and other related services, such us of hospital facilities, and such medical social services as are ordinarily furnished by the hospital for the care and treatment of inpatients, and such drugs, biologicals, supplies, appliances, and equipment, for use in the hospital, as are ordinarily furnished by such hospital for the care and treatment of inpatients. 42 U.S.C. 1395x(b)(1)-(2). (3) In an administrative bulletin from 1979, CMS, then HCFA, interpreted above-listed sections of the Medicare Act to prohibit the following services from being furnished under arrangement : i) Coronary intensive care; ii) iii) iv) Pharmacy drugs; Central supply items; IV solutions; and HCFA Administrative Bulletin #1347 (Apr. 10, 1979). v) Operating rooms. (v) Medicare pays for medical and other health services furnished to inpatients of the participating hospitals, whether such services are furnished directly by the hospital or obtained under arrangement. (vi) Incident to Physician Services: Hospital Outpatient Services and Supplies Furnished (a) 42 C.F.R (except for certain exceptions Medicare only pays for hospital outpatient services furnished directly by the hospital or under arrangement).

9 (b) 42 C.F.R (a)(1)(i)(providing coverage for hospital outpatient services and supplies furnished incident to physician services if furnished directly or under arrangement). (c) If services furnished at a department of a provider, as defined under the provider-based rules, must be under direct supervision of a physician. 42 C.F.R (f). (vii) Hospital Outpatient Diagnostic Services: (a) Medicare covers hospital outpatient diagnostic services whether such services are furnished directly or under arrangement. 42 C.F.R (a)(1). (b) In addition, Medicare covers such services regardless of whether the services are furnished in the hospital. Medicare Benefit Policy Manual (Pub ), Chapter 6, 20 (as revised by Transmittal 37, Change Request 3912 (Aug. 5, 2005), effective Sept. 12, 2005). b. Must the service comply with the provider-based rules? (i) The provider-based rules, 42 C.F.R , set forth the requirements that a facility or organization must satisfy in order to be treated as part of a main provider. For instance, a hospital that desires to open a sleep center off-campus and bill such services as hospital outpatient services would have to ensure that the sleep center meets the applicable requirements of the provider-based rules. (ii) CMS has adopted criteria and a process for determining whether a facility or organization my bill Medicare as a provider-based entity. The provider based rules include requirements that are applicable to all facilities or organizations, additional requirements that are applicable to off-campus facilities or organizations, and special additional requirements that are applicable to those off-campus facilities that are operated under management contracts. 2. Outsource Service Provider Bills for the Service. a. Must the hospital bill for the service? (i) Medicare requires that hospitals furnish or arrange for the furnishing of all items or services rendered to hospital outpatients during an encounter. 42 C.F.R (ii) This limitation is generally not applicable if the patient leaves the hospital for the service. See 65 Fed. Reg , (Apr. 7, 2000). b. Does Medicare impose any additional requirements if the joint venture entity bills for the service independently? For example, independent diagnostic testing

10 facility standards (42 C.F.R ) or ambulatory surgery center standards (42 C.F.R ). B. Is the outsource provider owned by physicians or has compensation relationships with physicians who make referrals to the hospital? 1. In other words, must we be concerned with the Stark law. 2. The Stark Law prohibits a physician from making referrals for Medicarepayable designated health services to any entity with which the physician or member of his or her immediate family has a financial relationship. 42 U.S.C. 1395nn; 42 C.F.R For purposes of the Stark Law, designated health services include: clinical laboratory services; physical therapy, occupational therapy, and speech-language pathology services; radiology and certain other imaging services; radiation therapy services and supplies; durable medical equipment and supplies; parenteral and enteral nutrients, equipment and supplies; prosthetics, orthotics, and prosthetic devices and supplies; home health services; outpatient prescription services; and inpatient and outpatient hospital services. 42 U.S.C. 1395nn(h)(6); 42 C.F.R Failure to comply with the Stark Law results in a number of possible sanctions. 42 U.S.C. 1395nn(g). For instance, payment of Medicare claims related to the provision of designated health services may be denied. In addition, any person who presents or causes to be presented a claim in violation of the Stark Law also may be subject to $15,000 civil penalty per service, an assessment of up to twice the amount of the claim, and possible exclusion from participation in the Medicare and Medicaid programs. 5. The Stark Law defines financial relationship broadly to include both compensation arrangements and ownership or investment interests. If a financial relationship exists between an entity and a physician, then all referrals from the physician to the entity for designated health services paid for in whole or part by Medicare are prohibited, unless the financial relationship satisfies an exception to the Stark Law. Further, the Stark Law encompasses both direct and indirect financial relationships. Accordingly, the Stark Law must be taken into account whenever a physician has a financial relationship with an entity that furnishes designated health services. 6. The Stark Law provides several means by which a physician can have an ownership interest in health care operations or service provider to a health care operator without implicating the Stark Law. However, even in such situations, the parties have to analyze all potential indirect financial relationships to ensure that such arrangements comply with the Stark Law. C. Will any party to the arrangement be in a position to generate referrals or other business to the arrangement? 1. The Anti-Kickback Statute prohibits, among other things, the offer, receipt, solicitation or payment of any "remuneration" to induce, or in return for: (1) referring a

11 patient for the furnishing of any service or item payable under a federal health care program, including Medicare or state Medicaid programs, or (2) ordering, arranging for, or recommending the ordering of, any service payable under a federal health care program, including Medicare or state Medicaid programs. 42 U.S.C. 1320a-7b(b). Violators of the Anti-Kickback Statute are subject to civil and criminal penalties, as well as exclusion from participation in any federal health care program, including Medicare and state Medicaid programs. 2. In the outsourcing context, the issues depend upon whether the arrangement is simply a contractual arrangement of if the arrangement is a joint venture. a. If the arrangement is contractual, the issues are whether the individual financial relationships comply with the Anti-Kickback Statute or whether the arrangement results in a contractual joint venture. b. In the joint venture context, the issue becomes whether the physician is being offered a chance to invest in the joint venture enterprise because of his or her ability to generate referrals for the joint venture or whether distributions from the joint venture enterprise are, in fact, disguised payments for referrals to the joint venture enterprise or to one of the other owners of the joint venture. 3. As a preliminary matter, both parties should be able to articulate the legitimate business reasons as to why they are entering into the proposed arrangement. Will the arrangement result in increased patient convenience, increased patient access, new services to patients, lower costs to patients, an increase in the quality outcomes, allow the hospital to redeploy under performing assets, prevent the physicians from competing directly with the hospital, etc.? Despite all other safeguards built into the arrangement, the parties should give some preliminary consideration and documentation as to why they are willing to enter the arrangement. 4. Because of the potential breadth of the Anti-Kickback Statute, Congress ordered the OIG to promulgate regulations under the Anti-Kickback Statute that create safe harbors for certain financial arrangements. See 42 C.F.R If a financial arrangement complies with all the requirements of a safe harbor, the OIG will not prosecute the arrangement regardless of the specific intent of the parties. It should be kept in mind that failure to meet the requirements of a safe harbor does not necessarily mean that an arrangement violates the Anti- Kickback Statute; it simply means that the transaction could be challenged by the OIG. 5. Unfortunately, many health care arrangements are not capable of being structured to comply with the applicable exception to the Anti-Kickback Statute. In such instances, it is necessary to look at all facts and circumstances to determine the risk factors for the particular transaction and to determine whether any safeguards can be built in adequately manage the Anti-Kickback Statute risks. 6. In its Special Fraud Alert on hospital-physician joint ventures, the OIG criticized many such joint ventures as simply an attempt to lock up a stream of referrals from physician investors and to compensate them indirectly for these referrals. OIG Special Fraud Alert (Aug. 1989), republished at 59 Fed. Reg. 65,372, 65,373 (1994). The Special Fraud

12 Alert identified the following questionable features that, separately or taken together, may result in a business arrangement that violates the anti-kickback law : referrals; than others; investment interests; a. Investors are chosen because they are in a position to make b. Large-referral sources are offered a greater investment opportunity c. Investors are actively encouraged to either refer or divest their d. The joint venture requires investors to divest their interests when they move out of the service area; e. The joint venture restricts the transferability of the investment; f. The joint venture tracks investor referrals and distributes this information to investors; services; g. The investment is in a shell entity that provides very few h. Investors receive a disproportionately large return on small investments as compared to other commercial activities; by investors; i. Participation in the joint venture requires only nominal investments j. Investors do not risk their own money, but instead borrow the money for the investment from the hospital; and k. Investor s returns are disproportionately high compared to the risk involved in the venture. 7. Typically, the joint venture is structured as close as possible to the applicable safe harbor. Although such structuring does not result in any safe harbor protection, it may demonstrate that the parties lacked requisite intent. 8. In April of 2003, the OIG published a Special Fraud Bulletin on Contractual Joint Ventures (the "Special Fraud Bulletin"). In the Special Fraud Bulletin, the OIG essentially takes the position that the Anti-Kickback Statute is potentially violated if a health care provider (the "Provider") outsources the development and management of an ancillary service line to an established provider of that ancillary service line (the "Ancillary Provider"). The OIG further takes the position that regardless of whether such arrangements fit within applicable safe harbors, the opportunity to bill given by the Ancillary Provider to the Provider constitutes a

13 "kickback." The OIG identifies the following "suspect" characteristics of such contractual joint ventures: 2 a. Expansion into a New Line of Business. The Provider is typically expanding into a new line of business. The Fraud Bulletin gave the following example: A hospital establishes a subsidiary to provide DME. The new subsidiary enters into a contract with an existing DME company to operate the new subsidiary and to provide the new subsidiary with DME inventory. The existing DME company already provides DME services comparable to those provided by the new hospital DME subsidiary and bills insurers and patients for them. b. Provider has a Captive Referral Base. Provider's new line of business predominately or exclusively serves the Provider's existing patient base. In these types of arrangements, the Provider is primarily motivated by capturing an ancillary revenue stream and does not typically plan to expand the new business line beyond its current patient base. c. The Provider Bears Little or No Risk Associated with the Ancillary Service Line. Provider's primary contribution to the contractual arrangement is referrals in that the Provider makes little or no financial investment in the ancillary service line. Instead, substantially all operations of the ancillary service line are delegated to the Ancillary Provider. Further, residual business risks, such as the risk for non-payment, are relatively ascertainable from past experience in the ancillary service line. In essence, the OIG takes the position that distributions to the owner of the ancillary service line, i.e., the Provider, are no more than payments for its referrals to the Ancillary Provider who is actually furnishing the service. d. Manager of the Ancillary Service is an Established Provider of that Service. The Ancillary Provider is both an established provider of the ancillary service line and also serves as manager of the ancillary service line on behalf of the Provider. That is, if the Provider established the ancillary service line itself, the Ancillary Provider would compete with the Provider to furnish the ancillary service line. The clear implication from the OIG is that such arrangements are agreements between would be competitors and the Ancillary Provider is simply "kicking back" the residual amount (i.e., reimbursement minus management fee) to gain access to the Provider's captive referral base. e. Scope of Services Furnished by Ancillary Provider in its Role as Manager. The OIG's point here is that the more "key" services furnished by the Ancillary Provider in its capacity as manager of the ancillary service line, the more likely it appears that the ancillary service is actually being furnished by the Ancillary Provider and not the Provider. In this regard, the OIG has identified the following services as "key" services: day-to-day management; billing services; equipment; personnel and related services; office space; training; and health care items, supplies, and services. Here again, the OIG's rationale is that if the Provider is not providing any key services relative to the ancillary service line, the Provider has 2 The OIG has indicated that "suspect" characteristics are not per se violations of the Anti-Kickback Statute but rather are an assessment by the OIG "that the practice itself is some evidence of a violation and serves as a warning to the health care industry that they participate in such activities at their own risk." Letter from Kevin G. McAnaney, the OIG Chief of Industry Guidance, dated as of Apr. 26, 2000 (available on line at:

14 no risk and, therefore, it would appear that the Provider is simply delivering captive referrals to the Ancillary Provider in return for its distributions. f. Remuneration, In the OIG's opinion, "[t]he practical effect of the arrangement, viewed in its entirety, is to provide the [Provider] the opportunity to bill insurers and patients for business otherwise provided by the [Ancillary Provider]." The OIG believes that this is further indicated by the fact that the remuneration (i.e., profits from the ancillary service line) to the Provider takes into account the value and volume of business the Provider generates. g. Exclusivity. Another suspect characteristic of such arrangements is that the parties often use restrictive covenants to limit competition between the Provider and the Ancillary Provider. That is, the parties may agree to either a non-compete provision whereby the Provider is barred from furnish the ancillary service line to any patients other than those coming from the Provider or a non-compete whereby the Ancillary Provider is barred from competing with the Provider to furnish services and items to the Provider's patients. The OIG clearly indicates that the list of suspect characteristics is not intended to be exhaustive and the "[t]he presence or absence of any one of these factors is not determinative of whether a particular arrangement is suspect." 9. In Advisory Opinion 04-17, the OIG refused to issue a favorable advisory opinion to a company (the Company ) that proposed to establish and manage off-site pathology laboratories for certain physician groups. Under the proposed arrangement, the Company would offer turn-key pathology lab operations to dermatology, gastroenterology and urology group practices at a centralized location. Through a series of agreements, the Company would establish the laboratory, manage the operations of the laboratory, provide necessary lab equipment and technical personnel to the laboratory, sublease the laboratory space to the physician group, arrange, through a related organization, the professional services of a pathologist, and, when requested by the physician group, provide billing and collection services. The physician group would own the laboratory, send its specimens to the laboratory, and bill globally for the professional and technical components of the pathology service. 10. Under the Company s business model, at a given location, it would establish up to five separate laboratories within the same building. Each laboratory, commonly referred to as a condo or pod laboratory, would have the full complement of equipment necessary to perform pathology services for the particular physician group leasing the space. Each laboratory space would be used exclusively for the tests of a particular physician group. Although the pathologists and technicians would be shared between the five laboratories, they would perform services for a particular physician group only when in that physician group s laboratory space. This model was established to allow each physician group to satisfy the centralized location requirement of the in-office ancillary services exception to the Stark Law. 11. Although the OIG reviewed the contractual relationships necessary to establish the arrangement (i.e., the management agreement, the technical personnel agreement, the space sub-lease, and the pathology services agreement), the OIG s refusal to grant a favorable opinion did not depend on the agreements. In fact, the OIG takes the position that the proposed arrangement would be problematic under the Anti-Kickback Statute even if each contractual arrangement satisfied the relevant safe harbor. Instead, the OIG based its decision on

15 its concerns over contractual joint ventures as expressed in its Special Advisory Bulletin issued in April, In Advisory Opinion 04-17, the OIG noted that the proposed arrangement shared the following characteristics of contractual joint ventures at issue in the Special Advisory Bulletin: a. Each physician group would be expanding into an ancillary service line (i.e., pathology services). physician group. b. The laboratory would depend solely upon referrals from the c. The physician group s participation in the laboratory s operations would be minimal and, according to the OIG, the physician group s business and financial risks would be nonexistent or minimal. d. Because the Company was a sister corporation (i.e., common parent corporation ownership) to an established supplier of pathology services, shared common officers and directors with the sister corporation, and had the ability assign contracts to the affiliated entities, the OIG took the position that it was appropriate to treat the Company as an established provider of pathology services. e. The Company s sister corporation, the laboratory, could provide pathology services in its own right and retain all reimbursement for such services. The OIG s unstated position is that, instead of competing for the physician group s business, the Company is, in essence, offering the physician group the opportunity to bill for such pathology services and retaining, through the various fee arrangements, a portion of the physician group s remuneration for pathology services. f. Payment to the Company would vary with referrals from the physician group to its pathology laboratory (as would the physician group s revenue). g. The Company and the physician group would share the economic benefit of the physician group s utilization of its pathology laboratory. Based upon the similarities between the proposed arrangement and the risk factors identified in its Special Advisory Bulletin, the OIG refused to issue a favorable advisory opinion because, in the end, it was unable to exclude the possibility that the parties contractual relationship is designed to permit the Requestor to do indirectly what it cannon do directly; that is, pay the Physician Groups a share of the profits from their laboratory referrals. D. Will the contract have cost sharing mechanisms? 1. The issue is whether we have to be concerned that the arrangement may be characterized as a gain sharing arrangement by the OIG. 3 Available at:

16 2. 42 U.S.C. 1320a-7a(b) (the CMP Law ) prohibits hospitals from: a. knowingly b. making a payment, directly or indirectly c. to a physician d. as an inducement to reduce or limit services e. with respect to Medicare/Medicaid beneficiaries f. who are under physician s direct care made 3. Penalty: $2000 per individual with respect to which such payment was 4. The OIG s position on gain sharing is set forth in a Special Advisory Bulletin issued in July 1999: 5. Keep in mind that this is only an issue if the outsource provider is owned by physicians or are paying physicians in a manner that may implicate the CMP Law. E. Will any party to the arrangement be a tax-exempt entity? 1. If so, the parties must take into account the excessive private benefit, private inurement and excessive compensation prohibitions. 2. F. Will the services be provided in bond-financed space? 1. If the service is going to be performed in bond financed, the Agreement must fit within a permissible contractual arrangement as set forth in Revenue Procedure (as amended by Revenue Procedure 01-39).. G. What will be the impact on hospital employees? 1. If hospital employees will be transferred to service provider, hospital must avoid appearance of discriminatory action, should adhered to employment agreements and traditional employment practices, must consider implications of the Worker Adjustment and Retraining Notification ( WARN ) Act of 1988, if applicable. 2. The hospital may want to negotiate mandatory hires by outsourced service provider, right of first refusal to rehire such employees, and specific indemnification for pretransfer, transfer and post-transfer of such employees. H. What is hospital s exposure for acts of outsourced service provider s employee and how does the hospital protect itself from such exposure?

17 1. The hospital should also understand that despite the fact that it is not the employee of the outsourced service provider s employees and contractors, it may be held liable for the actions of such persons under a variety of legal theories. 2. Many federal employment/labor laws and regulations recognize coemployer or joint employer liability, including the Fair Labor Standards Act ( FLSA ), the Family and Medical Leave Act, the Americans with Disabilities Act, the Age Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, the Equal Pay Act, and the National Labor Relations Act. 3. In Zheng v. Liberty Apparel Co. Inc., the 2 nd Circuit expanded the coemployment concept to outsourcing arrangements in the context of determining whether employees of an outsourcing company should be treated as co-employees of the company contracting with the outsource provider. Zheng v. Liberty Apparel Co. Inc., No , 2003 U.S. App. LEXIS (2d Cir. Dec. 30, 2003). I. Can the patient care service be furnished under the hospital s current license? J. Will the arrangement impact existing CONs or require additional CONs? K. Will Protected Health Information ( PHI ) flow to the outsource provider? taxes? VIII. L. Will the arrangement result in sales tax and who will be responsible for such Strategies for Success A. Develop Policies and Procedures to Address the Outsourcing of Clinical Services 1. Since a clinical outsourcing agreement is more than a mere procurement contract, the policy should address more than procurement issues, including clinical, liability, financial payments, insurance requirements, etc. 2. The policy should address necessary approvals, which, may include: legal, department administrator, risk management, medical staff, etc. B. Perform Adequate Due Diligence on the Provider. 1. As illustrated in the PhyAmerica case, hospitals can get stuck with their outsource provider for a significant period of time and their best way to manage such risk may be to simply do adequate due diligence on the outsource provider. 2. Remember, insurance and indemnity obligations are only as good as the ability of the outsource provider to pay such claims. C. Price Should Be A Factor Not The Factor. D. Measure and Manage Performance.

18 1. The outsource provider should be obligated to pay physicians and other persons performing services on behalf of the provider. 2. The contract should set forth clear performance standards to be measured and managed by the hospital. Further, the hospital should be able to engage in self help should such performance standards not be maintained. 3. Note that there is a dichotomy between wanting to be completely hands off for purposes of avoiding vicarious liability and being involved to manage risks. In such a balance, the hospital should typically lean towards managing risks since the courts (and plaintiff s attorneys) have been very creative in finding liability. E. Build in Contractual Wiggle Room for the Hospital. 1. A hospital should rarely contractually obligate itself to not furnish a service upon termination of an outsourcing arrangement. In fact, if the hospital is a tax-exempt hospital, one wonders if such a provision is ever in the best interests of the community served by the hospital. Further, if the service is furnished in bond-financed space, such a provision may result in a contractual arrangement that otherwise complies with the requirements of Revenue Procedure (as amended by Rev. Proc ) falling outside of the applicable safe harbors. 2. A hospital should also attempt to eliminate any restrictions on employing employees of the outsource provider upon termination or expiration of the outsource agreement. F. Build in Contractual Self Help for the Hospital. 1. For instance, if the outsource service provider fails to pay persons furnishing services at the hospital, the hospital should have the option of making such payments and off setting such payments from amounts due to the outsource service provider. G. Stay Involved in the Service. 1. The service remains the hospital s service and, often, the hospital will be drug into any liability arising out of the service. Accordingly, hospitals should resist the urge to outsource and only worry about the service when a problem arises. a. Appoint a service liaison who attends department meetings, monitors performance, and reports to management and the board on the service. H. Only Use Appropriate Incentives. Depending on the facts of the particular arrangement, the incentive compensation methodology used, if any, should: 1. Be subject to an overall cap set as determined based upon a fair market valuation (especially if the outsource provider is in the position to generate referrals); 2. Not be determined in any manner that takes into account the volume or value of any referrals (or other business generated by) any physicians associated with the outsource provider;

19 3. Not result in the outsource provider or any owner of the outsource provider sharing in the net profits operations of the hospital (only applicable if tax-exempt hospital); 4. Contain safeguards to prevent inappropriate utilization; and 5. Not result in any incentive to physicians to limit or reduce services to Federal health care program beneficiaries. I. Always Have the Ability to Make A Quick Exit.

20 Attachments Attachment A Waller Lansden s 2006 Hospital Outsourcing Trends in Clinical Services Survey Attachment B Additional Analysis of 2006 Hospital Outsourcing Trends in Clinical Services Survey Data (coauthored by Reggie Hill, Thomas Bartrum & Bobby Guy) Attachment C ABA Health Lawyer Article by Bobby Guy & Thomas Bartrum Attachment D Magazine Article by Reggie Hill & Bobby Guy