In the midst of the COVID-19 crisis, the California Legislature has been considering Senate Bill 977 (“SB 977”). If passed, SB 977 will significantly extend the California Attorney General’s reach into the private sector and cause a chilling effect on health care transactional activities in California. The bill as currently proposed aims to (i) significantly expand the power of the California Attorney General (the “AG”) to review and approve health care transactions in the state, (ii) expand the AG’s ability to pursue litigation against health care systems for anticompetitive conduct; and (iii) create a new health policy advisory board that advises the AG on whether to approve transactions and evaluates health care market conditions in general. A detailed summary of the bill is available at our companion blog post.
Over the last ten years, California (along with the rest of the country) has seen a significant amount of consolidation in health care providers due to reductions in reimbursements and in a quest for efficiency and access. This has created increasingly large multi-facility hospital systems, as well as multi-specialty physician practices and medical foundations. However, some have expressed concerns that certain consolidations have led to increased costs and decreased access and quality.
The AG’s existing review authority is fairly limited, and it only applies to the transfers of nonprofit health care facilities. That leaves a vast spectrum of consolidating activities in the provider space unchecked. SB 977 is an attempt to subject more consolidations and acquisitions to AG review before closing, and also give more power to the AG to scrutinize the anti-competitiveness of a transaction after closing. The bill, if passed, will lead to significant burden and uncertainty on a large number of potential transactions in the state, which will undoubtedly cause an overall chilling effect on health care transactions in California.
SB 977 Leaves Struggling Providers with Fewer Options
SB 977 captures transactions where the seller is a solo practitioner or small group, standalone hospital, or rural health care facility (the waiver only applies to buyers that are located in a rural area). These are often the most vulnerable providers that are in most need of affiliation or acquisition, particularly in light of the economic distress caused by the COVID-19 pandemic. Under this financial pressure, these providers may be forced to choose between closing or undertaking a sale or investment transaction.
Depending on the geographic market, the most viable partners for such providers are likely large health care systems or investor groups such as private equity firms. Under SB 977, this type of transaction could trigger AG approval. This significantly increases the procedural burden and costs in completing the transaction and may discourage certain buyers from even entertaining the transaction. Without a viable buyer or investor, these providers may end up ceasing practice, which reduces competition and access to care – precisely the concerns the Legislature aims to address with SB 977.
SB 977’s Application to MSO Structure Unclear
Aside from the consolidation trend over the past decade, there has also been an increase in private equity (“PE”) investment in health care provider entities. Due to California’s corporate practice bar, PE firms often adopt a “friendly PC” or MSO (management services organization) model where the PE firm owns a management entity that provides business support services to clinical practices and receive a management fee that reflects the economics of the practice. Patient advocacy groups have argued that PE-backed practices are focused on maximizing profit to the detriment of quality of care, although there can be sound business motivations to have non-clinicians focus on the business aspects of the practice while letting clinicians focus on patient care.
SB 977 seems to apply to PE and hedge fund transactions that utilize a management model. However, the definition of “acquisition” and “change of control” does not specifically call out management services arrangements, creating ambiguity as to whether such arrangements fall within the scope of SB 977 as currently drafted. Regardless of the intent, SB 977 will likely put California providers at a disadvantage compared to those in other states in attracting PE and hedge fund investors.
SB 977 Will Increase Antitrust Enforcement
SB 977 would provide renewed momentum for the AG in reviewing payor-provider relationships for anticompetitive behavior. The bill expands the AG’s current antitrust authority in reviewing anticompetitive conduct by health care systems and reduces the need for judicial interpretation regarding certain key definitions and presumptions. The bill defines what constitutes “tying” and “exclusive dealing” and creates presumptions of unlawfulness. This gives the AG a significant advantage in litigation against health care systems for alleged anticompetitive behavior, particularly with respect to contracting with health plans. As such, if SB 977 passes, health care systems should be prepared for the AG to bring more cases like the recent Sutter Health case, where Sutter Health settled with the AG for $575 million. The fines and settlements imposed on providers could also lead to increased cost and negatively impact delivery of patient care services.
Future Outlook
Despite sailing through the Senate, it is unclear whether SB 977 will actually pass into law. It is facing significant pushback from many industry groups, including the California Hospital Association, California Medical Association, and California Dental Association. SB 977 barely passed out of the Assembly Health Committee with the minimum number of votes on August 5. It now heads to the Assembly Appropriations Committee for a hearing on August 18, and that committee must pass the bill by August 21 if it were to move forward. If it passes out of that committee, the bill must be approved by both the Assembly and the Senate by August 31. If both the Assembly and Senate pass SB 977, the Governor will have until September 30 to sign the bill. If signed by the Governor, SB 977 will become law on January 1, 2021 and begin to impact transactions closing on or after January 1, 2021.
SB 977 as currently drafted would chill transactions to acquire struggling providers, would create uncertainty for private equity/hedge fund health care transactions, and would increase and expand the AG’s antitrust enforcement. Even if this bill fails in the current session, the concerns giving rise to it may not be put to rest. We anticipate continued effort by the Legislature to increase regulatory oversight over health care consolidations, even as the financial viability of many health care providers hangs in the balance.