Transactions in the healthcare industry need to meet the threshold of commercial reasonableness to avoid regulatory sanctions. It is critical that healthcare entities contemplating a transaction be aware of the factors to consider and the appropriate documentation needed to ensure compliance and withstand scrutiny.
While varying, yet similar definitions of commercial reasonableness exist, The Centers for Medicare & Medicaid Services (CMS) summarized the fundamental meaning of commercial reasonableness by stating 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 (or family member or group practice) of similar scope and specialty, even if there were no potential designated health services (DHS) referrals.”
The basic elements of a commercial reasonableness analysis include assessing if a transaction represents a prudent business arrangement in the absence of referrals and confirming that all elements of the transaction do not exceed fair market value. The concept of fair market value is separate and distinct from the concept of commercial reasonableness. A fair market value analysis reflects the value to hypothetical buyers and sellers while a commercial reasonableness analysis reflects entity specific assumptions. If any element of a transaction exceeds fair market value, it would not be considered to be commercially reasonable. However, it is important to note that even if all elements of a transaction meet the fair market value threshold, this fact alone is not sufficient to meet the commercial reasonableness threshold.
A commercial reasonableness analysis encompasses both a quantitative analysis of the components of a transaction as well as various qualitative considerations:
A quantitative analysis for a commercial reasonableness assessment involves assessing the financial feasibility of the transaction. The quantitative analysis should include an examination of the economic cost/benefit of the transaction using various techniques such as internal rate of return and net present value. This helps determine if the financial terms of transaction reflect terms that other prudent investors would consider reasonable. The quantitative analysis will also consider any synergies or changes to the organization’s risk profile resulting from the transaction.
The qualitative analysis of a commercial reasonableness assessment is broad in scope and considers whether the transaction achieves a business purpose without consideration of referrals. The factors examined as a part of this analysis include:
- (Necessity) Is the proposed transaction necessary to achieve a legitimate business purpose?
- (Nature and Scope) Is the cost associated with the nature and scope of services provided a reasonable business expense?
- (Organizational Elements) Does the arrangement contribute to strategic goals and/or profits excluding any income from referrals? What are the local economic conditions and does patient demand and/or community need justify the proposed transaction?
- (Quality, Comparability and Availability) How do the services included in the proposed transaction compare to the availability, terms and rate of services offered by non-referral sources?
- (Legally Permissible) Is the transaction legally permissible based on a review by legal counsel?
- (Independence and Oversight) Is there a formal process in place to evaluate the effectiveness and performance of the arrangement?
Given the increased volume and complexity of healthcare transactions in recent years, a comprehensive assessment of commercial reasonableness is necessary to reduce the vulnerability of an organization to regulatory scrutiny. Generally, legal counsel will rely on the opinion of an independent valuation expert to determine whether a transaction is in compliance with commercial reasonableness requirements. An experienced valuation expert that is well-versed in quantitative and qualitative elements of commercial reasonableness can assist with obtaining the necessary documentation.
Tami Bolder is a Senior Manager in the Akron office of CBIZ MHM, LLC, an independent CPA firm. She provides business valuations and litigation consulting services.