Early Specialized Diligence: The Prescription for Successful Healthcare Finance Lending

Failing to understand how a company operates within its regulatory framework or whether it is in compliance with its regulators early in the process could delay closing significantly or, worse yet, stop it from happening at all. Although it would be impossible to detail all the federal and state laws and regulations applicable to healthcare related companies and the potential diligence issues that could arise in a healthcare financing, this article offers an approach for lenders to perform efficient diligence on healthcare companies in connection with a lending transaction.

The first step toward successfully completing diligence of a healthcare finance transaction is to recognize that specialized diligence must be undertaken. Asking these simple questions will reveal whether healthcare related regulatory oversight is implicated:

• Does the borrower provide a medical service or product?
• Does the borrower regularly do business with a medical service provider or a medical product manufacturer or distributor?
• Does the borrower obtain payment for its services or products from a private health insurance company or a government reimbursement program?

Which Regulations Apply?

The most common regulations implicated by most healthcare businesses are the Federal Anti-Kickback Statute, the Federal Physician Self-Referral Law (Stark Law), HIPPA, the False Claims Act and the Corporate Practice of Medicine just to name a few. However, which regulations are applicable will depend on which type of provider the company is and whether the provider participates in a government reimbursement program. Consequently, consulting healthcare finance and regulatory specialists is critical. Once the applicable regulations are determined, the due diligence request may be tailored to focus on whether any of the regulations affect:

• The structure of the lending transaction
• The collateral pool
• A borrower’s financial performance, especially if the borrower is out of compliance with the regulations

Accordingly, at the outset, before the diligence request is even drafted, a lender should ask a few crucial questions of the borrower regarding its compliance with regulations. These initial questions will facilitate an efficient and appropriate approach to the diligence process. Again, these questions will depend on the company’s business, with examples including:

• Is the company currently negotiating or subject to a Corporate Integrity Agreement related to non-compliance of regulations?
• Is the company currently negotiating a settlement for a material overpayment with a third-party payor such as Medicare?
• Is the company aware of any whistleblower suits filed against it?
• Is the company subject to any civil monetary penalties resulting from the failure to comply with regulations?

How is the Borrower Paid?

First, the types of payors a healthcare company contracts with may vary. Typically, healthcare providers will receive a mix of payments from government reimbursement programs (such as Medicare and Medicaid), commercial insurance companies and patients themselves (which is known as self-pay).

Third, providers participating in government reimbursement programs may receive additional compensation through programs other than traditional Medicare/Medicaid, including quality assurance fees for hospitals or enhanced reimbursement for skilled nursing facilities via participation in an upper payment limit program (UPL). If so, a lender will need to understand how and to whom these payments are made as well as what would happen to a borrower’s financial performance if the payments were delayed for any reason, if the borrower were no longer entitled to participate in the program, or if the program was eliminated.

Once a lender understands the support the borrower has obtained as well as its anticipated impact on future cash flows, the next step will be to determine how this support should be treated in accordance with loan documentation covenants and, in particular, any financial covenant definitions.

There is no doubt that there are unique considerations for healthcare finance deals. Asking questions focused on the key areas outlined in this article early and conducting specialized healthcare diligence along with customary financial and legal diligence will pave the way for a more efficient and tailored diligence process and, ultimately, a smoother execution.

1. NHE Fact Sheet, CMS Medicare and Medicaid.

Stacy Hopkins is of counsel at Paul Hastings. Her finance and restructuring practice focuses on commercial finance and creditors’ rights. She advises clients on structuring, negotiating and documenting cash flow and asset-based transactions across all lifecycles of a loan. Prior to rejoining Paul Hastings, Hopkins served as senior vice president in the healthcare finance group at Wells Fargo Commercial Capital.