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TO: Public Health Council
State Hospital Review and Planning Council
FROM: Henry M. Greenberg, General Counsel
DATE: September 21, 1999
SUBJECT: Certificate of Need Applications:
The Council is presented with a number of Certificate of Need ("CON") applications, involving ownership changes of dialysis facilities, that share certain common structural characteristics. In these applications, an entity (hereinafter referred to as an "Outside Entity"), which has not itself received establishment approval, has a significant role in facility acquisition and operation. The applicant is a business corporation, with a single shareholder, officer and director, which owns the "Article 28 assets'' of the facility. The applicant's sole shareholder is an employee of or has some other contractual arrangement with, the Outside Entity. The Outside Entity owns or leases the "non-Article 28 assets", which are then leased to the applicant. The Outside Entity may also be the tenant under the facility's lease, which is then subleased to the applicant. Additionally, the Outside Entity provides consulting and administrative services to the facility and may provide partial or total financing. Through these various relationships, a significant amount of the facility's revenue may flow to the Outside Entity. As part of the consideration, the shareholder agrees with the Outside Entity that, under certain circumstances and upon specified conditions, the shareholder will sell the stock to a designee or representative of the Outside Entity. We understand these types of arrangements are increasingly being used in the dialysis field to provide a source of capital and as a means of permitting an Outside Entity to offer its economies of scale and expertise to New York facilities.
Notably, while this describes certain salient features of the applications for operational changes for dialysis facilities which are now before the Council, there may be other possible structures for these types of arrangements. Additionally, there will be similar applications on future agendas, and there has been one already, for the establishment of ambulatory surgery centers. These types of arrangements are increasingly being used in the ambulatory surgery field for the same reasons as in the dialysis field.
In light of the operational restrictions set forth in PHI, Article 28, and given that the Outside Entity is not itself the established operator, is the arrangement described above between an Outside Entity and an established operator of a dialysis facility or ambulatory surgery center ("ASC") legally permissible?
Yes. The representative governance arrangement described above is legally permissible provided that: (i) the established operator of the dialysis facility or ASC retains ultimate power and authority over, and responsibility for, the facility's operations; (ii) the approved shareholder is the sole beneficial owner of the stock; (iii) any subsequent transfers of stock or voting rights of ten percent or more, or transfers resulting in a person owning ten percent or more of stock or voting rights, are approved by the Public Health Council; and (iv) the project does not involve an improper sharing of facility revenue. It bears emphasis that we address herein only those "representative governance" arrangements that the Council has seen to date for dialysis facilities and ASCs and that our conclusions apply only to these types of Article 28 facilities.
State law and regulation provide certain essential elements for Article 28 establishment and ownership, unique to New York. Applicants are required to receive establishment approval through a clearly prescribed process and, as Article 28 operators, must maintain accountability for, and ultimate authority over, facility operations. In order for an applicant to receive establishment approval, the Council must be satisfied as to the applicant's "character, competence, and standing in the community and as to the project's financial feasibility. Additionally, as part of the establishment process, owners of an applicant are required to affirm that they are the "sole beneficial owner" of the ownership interest held in their name. On an ongoing basis, certain governing powers, sometimes described as "reserved powers", and ultimate authority and responsibility, must be retained by the established operators. Finally, no person, other than the established operator, may share in facility revenue.
The "representative governance" arrangement complies with all of these essential elements and, therefore, the overall arrangement for dialysis facilities and ASCs is legally permissible. We will discuss each element in turn.
A. Character and Competence
In each application, the person who will be the sole shareholder has undergone satisfactory character and competence review, which will also be required of any subsequent holder of ten percent or more of the stock. Additionally, and in recognition of the participation of the Outside Entity in the facility's operation, the Outside Entity itself has undergone satisfactory "organizational" character and competence review).
Regardless of whether the Outside Entity directs to whom the shareholder may sell shares, when the shares may be sold, and for what consideration, the transfer itself must comply with applicable law and the stock may only be transferred to a permissible Article 28 operator. If the amount of stock transferred is greater than ten percent or if the transfer results in the ownership of ten percent or more of the stock by a permissible owner who has not undergone character and competence review, the Council's approval would be necessary for the stock transfer.
B. Sole Beneficial Ownership
Beneficial owners of stock must possess the rights to vote and to receive dividends. By exercising the right to vote, a shareholder elects the Board of Directors, who are vested with the authority to conduct the corporation's business. In each application, the established operator retains these essential rights and has provided an affidavit of sole beneficial ownership.
C. Reserved Powers
The integral components of ultimate operational authority have been identified by regulation and include overall responsibility for the management and operation of the facility in compliance with applicable laws, rules and regulations. These powers must be reserved to the governing authority (which, in the case of a corporation includes the Board of Directors, officers and shareholders) of the established operator and cannot be delegated to a non-established entity. For each application, we are working with the applicant to ensure that all pertinent legal documentation (such as loan agreements, consulting agreements, etc.) reflect the retention of these reserved powers and overall responsibility by the applicant and the need for compliance with applicable law for transfers of stock or voting rights.
D. Financial Feasibility and Revenue Sharing
A project must be financially feasible in order to receive CON approval20. In reviewing the financial feasibility of a project, the impact of the fact that revenue flows through to the Outside Entity must be considered. No person, other than the established operator, may share the revenue of an Article 28 facility21. Therefore, compensation arrangements cannot be based on a percentage of revenue and must be commercially reasonable under the particular circumstances.
We expect to see in the future similar CON applications from dialysis facilities and ASCs. If the Council approves, the principles outlined in this memorandum will serve as a guide for review of such applications, each of which must be reviewed on a case-by-case basis. The use of these principles will insure the integrity of the establishment process, while allowing dialysis facilities and ASCs the flexibility needed to provide high quality, cost-efficient health care services in the current health care marketplace.
1. There have been a small number of similar projects, which received contingent approval, on past agendas.
2. These have been defined in purchase and sale agreements as those assets which only a person who has received establishment approval can own. Such assets would include the CON itself, the facility name and contracts with professionals and key management employees.
3. In the current applications, the Outside Entity is a publicly-traded company which is not itself a permitted Article 28 operator. See Public: Health Law ("PHL") § 2801-a(4)(e).
4. These would include furniture, fixtures, equipment and supplies for the facility.
5. PHL § 2801-a(3)(b).
6. See PHL § 2801-a(3)(c).
7. See Title 10 (Health) of the Official Compilation of the Codes, Rules and Regulations of the State of New York (10 NYCRR) § 620. l(b)(1).
8. See l0 NYCRR § 405.1(c).
9. See l0 NYCRR § 600.9(c).
10. See PHL § 2801-a(4)(b)(i) and (c).
11. See PHL § 2801-a(3)(d).
12. Shareholders may enter into agreements (such as rights of first refusal, put/call options, etc.) with other shareholders and/or third parties regarding the transfer of stock and voting rights, provided that such transfers are in compliance with PHL § 2801-a(4)(b).
13. If the Outside Entity is a publicly-traded corporation, as it is in this instance, absent legislative change, the stock could not be transferred to the Outside Entity itself. See PHL § 2801-a(a)(e).
14. Id. at 11.
15. See 14A NY Jur.2d (Business Relationships) §§ 832, 903 and 1016.
16. See Business Corporation Law § 701; 14 A NYJur2d (Business Relationships) §§ 829 and 832.
17. Retention of these rights does not necessarily mean that such rights cannot be encumbered. For example, lenders may require that a certain key individual remain involved with a borrower and may prohibit the issuance of dividends depending on such matters as the cash flow of the business and whether loan payments are current. These are commercially reasonable restrictions which do not extinguish the fundamental fights to vote and receive dividends.
18. See l0 NYCRR §§ 405.1(c) and 751.2.
19. See l0 NYCRR § 600.9(b).
20. See PHL § 28Ol-a(3)(c).
21. See 10 NYCRR § 600.9(c).
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