by Kathleen Roney
Due diligence is a necessary step in a transaction. Whether it is a clinical affiliation or a full sale, due diligence is conducted so both parties fully understand the other. According to Michael Daray, lead attorney in the healthcare practice at Law Weathers in Grand Rapids, Mich., whether the transaction involves a hospital acquisition of a practice or another hospital, the same general principles apply in effectively and efficiently conducting due diligence. The first step should be to develop a robust due diligence checklist.
“It is more of an organization issue. It helps clarify the important items that the respective parties need to focus on. It’s easy if you don’t have some sort of checklist or other list identifying issues to get bogged down on certain issues while neglecting others. From an organizational standpoint [the checklist] puts everyone on same page as for what needs to be done,” says Daray.
The checklist should comprise 10 crucial categories:
1. Legal matters. Legal matters should be first on the list because they involve an extensive examination of the corporate structure and organizational documents for the target entity.
“The target entity should provide a copy of all of its corporate records. Then, legal counsel for the acquiring hospital should review these documents and provide an appropriate summary to executives,” says Daray.
2. Financial matters. According to Daray, financial matters can reveal a great deal about a potential partner. “If a target has unaudited financials only, it raises the issue as to what extent the financials accurately reflect the condition of the target and its operations.”
The following elements of a target entity’s finances should be covered in due diligence and reviewed by the acquiring hospital’s accountants and tax advisors:
• Current financials;
• Audited financials for the preceding six years;
• All tax returns filed within the last six years;
• Audit letters from any tax authority for the past six years, as well as determination letters regarding same;
• A statement regarding the accounting methods used by the target and any changes in them;
• All documents from the IRS with respect to the target’s 501(c)(3) status; and
• Payor mix data.
3. Indebtedness. The target should provide a description and supporting documents regarding any borrowed monies or guaranties given by the target.
4. Assets. The target hospital should provide an exhaustive list and description of its assets. According to Daray, this list should contain all tangible personal property, real property and intangible assets.
The tangible personal property includes equipment in the hospital that is used for the delivery of healthcare services — such as imaging equipment and equipment in an examination room. The condition of the equipment should be documented as well.
The real property includes the property on which the hospital is located, whether owned or leased. “Many target entities have facilities beyond the main campus. Any clinics or ancillary facilities should be accounted for in the transaction,” says Daray.
Finally, the intangible property includes contracts and licenses such as those for health information technology and software. “Sometimes there are requirements for obtaining a vendor’s consent to utilize software post-closing. If those consents are not obtained, the hospital may be required to purchase new licenses, which typically entails significant costs,” says Daray.
5. Regulatory matters. According to Daray, a target entity should provide all information regarding governmental approvals and permits it has received in order to operate as it does. This will include approvals relating to participation in federal payor programs as well as approvals with respect to the target’s operations.
“The target should also provide all documents pertaining to any investigation by any governmental authority regarding alleged violations of applicable law, as well as the resolution of those investigations,” says Daray.
6. Environmental matters. In order to guarantee each party’s compliance with all applicable environmental laws, all information and documents regarding environmental matters affecting the target entity should be reviewed in due diligence.
“Healthcare facilities, like any other operation, can generate hazardous waste, often in the form of biomedical waste. You want to make sure a target entity is operating in accordance with environmental laws,” says Daray.
Hospitals should request copies of all environmental reports as well as documents regarding any allegations of violation of laws or permits and the resolution of those allegations. This may require the engagement of an environmental consultant, especially if additional environmental inspection or testing is warranted,” says Daray.
7. Contracts. The target hospital should provide copies of all material contracts. According to Daray, this will include contracts with all payors, managed care contracts, professional services agreements and physician employment agreements. Other agreements that should be provided include supply agreements, lease agreements — including both real and personal property leases — long term agreements, management agreements and licensing agreements.
“If the agreements are oral in nature, the target entity should provide a written description. If there is any dispute between the parties on any of the agreements, the target should provide a written description of the dispute,” says Daray.
8. Employee matters. Any oversight in employee matters could have a negative impact post-transaction, so due diligence is extremely important in this area, according to Daray.
“For example, assume a target hospital provides opportunities for its providers to conduct research. In some cases, the providers conducting that research may not have agreements with the hospital regarding ownership of the intellectual property rights regarding research. If an acquirer assumes that they are acquiring property rights generated by providers in the course of that research, they may be surprised,” says Daray.
“Surprises could also occur with employee benefit plans such as pension plans that, if underfunded, may become the responsibility of the acquiring hospital. The acquiring hospital needs to understand the current state of employee matters so it can determine what liabilities may exist if the acquisition goes through and the employees of the target entity are hired by the acquiring hospital.”
Information and documentation on employee matters should include:
• Current employees, including dates of hire, positions and compensation;
• Employee benefit plans, including pension plans, profit sharing plans and health plans;
• Compensation plans including bonus arrangements;
• Employee handbook and policies;
• Employment agreements and collective bargaining agreements; and
• Any allegation of violation of applicable law and any resolutions.
9. Insurance. A target hospital should provide information and documentation regarding all policies of insurance in place, as well as a detailed history of claims and pending claims. This category is important in order to avoid acquiring or affiliating with a target entity that does not deliver the quality of healthcare services expected by the acquiring hospital, explains Daray.
“You are focusing in large measure on medical malpractice claims. You want to get a sense of what type of claims have been filed by patients or by individuals on the premises of the hospital,” says Daray. “If you are dealing with a situation where the target entity has extensive claims regarding the services rendered, it raises questions as to whether the quality of the services generally meets the level required by applicable law.”
10. Litigation. According to Daray, the acquiring hospital should request a detailed description of all litigation pending or initiated within the previous six years, along with the resolution of each.
In addition to covering these 10 issues, a due diligence checklist should allow for status notes to be inserted to track the progress of outstanding due diligence items. According to Daray, it is not enough to request information for robust due diligence. The information must be thoroughly reviewed by the appropriate advisor to the acquiring hospital, whether it be a financial advisor, an accountant or an attorney.
Sometimes the due diligence process, including merely requesting information on the above 10 categories, can be revealing in itself. “If the target entity is reluctant to provide information with respect to its operations, for example, it raises the perception that something is wrong — that there is something to hide,” says Daray. A checklist helps to organize the due diligence process as well as to guarantee that all issues are covered, bringing potential red flags to the surface early.
This article was written by Kathleen Roney and originally published on beckershospitalreview