In a decision issued June 15, 2022, the United States District Court for the District of Arizona issued an opinion in the case of United States, ex rel. Kuzma v. Northern Arizona Healthcare Corporation, et al. that offers an in-depth, cautionary analysis to hospitals and physicians respecting the use of valuation opinions and standards to assess fair market value in the context of hospital and physician transactions. The court's opinion held that there were disputed issues of material fact that precluded summary judgment in favor of defendants Northern Arizona Healthcare Corporation, Northern Arizona Orthopedic Surgery Center and Flagstaff Medical Center (collectively NAHC). Through an examination of the factual circumstances, the court identifies best practices for health system counsel that valuation experts and business strategists and financial officers ought to carefully consider.
The relevant factual background generally recited by the court was as follows: when NAHC acquired the Summit Surgery and Recovery Care Center (Summit Center) at the end of 2014, it was owned by 16 physician owners. The NAHC began to negotiate with the physician owners of the Summit Center in 2013. While employed by NAHC, Mr. Kuzma, a financial officer there (Relator) allegedly conducted a "high-level business valuation" of the Summit Center and concluded that it had a fair market value in the range of $8 to $10 Million. On December 31, 2014, NAHC, however, purchased the assets of the Summit Center for $25,125,000. Relator alleged in the suit that NAHC violated the False Claims Act by paying in excess of fair market value to the physician owners of the Summit Center as a reward them for past business and to induce future business in violation of the Anti-Kickback Statute at 42 U.S.C. § 1320a – 7b. Relator then alleged that all claims submitted to governmental healthcare programs for services performed by the physician owners at facilities of NAHC after the purchase of the Summit Center violated the False Claims Act.
In an important cautionary analysis, the court rejected NAHC's argument that there could be no False Claims Act violation arising from the purchase of the Summit Center because there an independent fair market valuation by a highly qualified valuation firm existed, supporting the transaction price (albeit, at the high end of the fair market value range). As well, NAHC pointed out there was another qualified business firm that reviewed the valuation work and performed a strategic analysis of the transaction. Although Relator had not performed a full fair market valuation, the court nonetheless concluded that there were disputed issues of material fact regarding the accuracy and legitimacy of NAHC valuation that precluded the grant of summary judgment. In so doing, the court also held that there was disputed evidence as to whether the purchase price was commercially reasonable.
Relator asserted that aside from the validity of his high-level valuation there was sufficient evidence that the NAHC valuation was inflated because the valuation firm assumed future capital expenditures of $900,000 over six years but NAHC supposedly had told another professional firm that almost $2 Million in replacement equipment would be required soon after the valuation. Relator also alleged that the valuation firm relied on information from the physician owners without challenging it. In this connection, Relator argued that the valuation did not account for costs associated with a clinical services management agreement (presumably requiring an expense adjustment), accepted as face value projected future case volume increases despite NAHC internal predictions that case volume would decrease, failed to take into account 2014 year end data showing deteriorations in volume and performance trends, and did not consider information on historic trends in the revenues or expenses of the Summit Center.
The parties agreed upon the relevant legal standard as being set by a case from twenty (20) years ago in United States, ex rel. Obert-Hong v. Advoc. Healthcare, 211 F. Supp. 2d 1045 (N.D. Ill. 2002). Pursuant to that standard, “to comply with the Anti-Kickback Statute, the hospital must simply pay fair market value for the practice’s assets” and a court may “infer that an excess over fair value is intended to induce referrals.” 211 F. Supp. 2d 1049 and n.3. The court also quoted and relied upon Obert-Hong’s reasoning that a fair market valuation in the Anti-Kickback Statute context “may differ from traditional economic valuation formulae. Normally, we would expect the acquisition price to account for potential revenues from future referrals. Because the [AKS] prohibits any inducement for those referrals, however, they must be excluded from any calculation of fair value here.” Obert-Hong, 211 F. Supp. 2d at 1049, n.2.
The NAHC court held that the evidence of the Relator including his own desk level opinion, and the substantive deficiencies he identified in the NAHC valuation created a disputed issue of material fact precluding summary judgment. Practically, such a finding puts enormous pressure on any defendant to resolve the litigation given the enormous stakes at issue. For example, for NAHC the court’s decision would permit damages evidence to go to trial that would include evidence regarding all hospital procedures performed by Summit physicians at NAHC since early 2015.
The court rejected that argument that “quibbles over professional judgment” could create a factual dispute precluding summary judgment in each case involving the value of purchased physician group assets. Instead, the court held that Relator had identified concrete errors in the valuation, including the omission or understatement of known costs. Accordingly, the court held that summary judgment was not appropriate from the threshold issue of fair market value as providing a basis for a violation of the Anti-Kickback Statute.
The court also rejected the argument that Relator could not establish scienter, or a knowing and willful violation of the AKS. In discussing the scienter issue, the court cited documentation that would commonly be found within the business office assessing such a transaction. Such materials include draft presentations referencing that the orthopedic services would be an anchor service line for creating a strong patient base to obtain referrals and testimony that NAHC anticipated future referrals and the preclusion of out-migration of surgical cases because of the transaction. Moreover, the court held that Relator showed that there was no meaningful review internally or externally by counsel or otherwise of the independent valuation. Further, the valuation was completed as of a date several months prior to the closing, was still marked as a draft, and omitted most recent financial performance data showing downward performance trends. All this evidence the court found could go to a jury on the issue of scienter as to whether defendants acted with actual knowledge or deliberate ignorance of the over payment for the assets of the Summit Center. The evidence also would satisfy any willful requirement, including evidence that creation and branding of a continuum of orthopedic and spine services to allow NAHC to be a premier provider for comprehensive and convenient orthopedic services with resulting patient referrals also went directly to issues of willfulness and scienter.
Finally, the court also held that the Relator could present the issue of causation to the jury meaning that the Relator could argue that but for the acquisition in excess of fair market value, all the subsequent procedures and referrals by the orthopedic surgeons would amount to tainted false claims. In this regard, the court also alluded to evidence regarding a three-year non-compete following the acquisition as indication of but for causation. In a blunt analysis, the court held that such evidence could show that the professional judgment of each of the physicians had somehow been impacted.
In short, the NAHC decision sets out a series of cautionary analyses that providers and their counsel should heed. Among other foibles that the court identified were: the fact that the valuation was not brought current prior to the closing; the fact that the valuation did not take into account the most recent volume trends; alleged reliance upon data the practice presented without adequate external assessment; the fact that the valuation took into account the value of referrals presumably through reliance upon an income-based valuation approach; the lack of any external or internal check on the valuation that could have caught errors within the accounting within the valuation as well as errors within the valuation approach in assessing fair market valuation. Further, the court's emphasis on the internal business strategy of creating an orthopedic line of excellence with attendant referrals again is a very important cautionary measure for healthcare counsel and internal business officers as to compliant processes to adopt and undertake when considering any type of transaction with referral sources. In short, the existence of a professional valuation provides no defense to an allegation of a violation of the Anti-Kickback Statute if the valuation is overstated. That is particularly true when there has been no check on the valuation process and internal business strategy suggests that the transaction would broaden the footprint of a healthcare system within a particular market.
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