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INSTITUTIONAL LICENSING IN NEW YORK STATE:

OWNERSHIP BY PUBLIC COMPANIES

This will be an examination of the current state of the law in New York as administered by the various agencies that license health and mental health care institutions with respect to ownership of those institutions by publicly traded corporations. There are three broad categories of licensed institutions: Those that can be owned by publicly traded corporations; those that may not be owned by publicly traded corporations and, as might be expected in the interesting area of health law, a gray area where the law is unclear. The author will examine the state of the law here as revealed by the law, regulations, conversations with the regulators and experienced practitioners and his own experience in this area.

This article, however, will commence a new initiative of continuing education by the Health Law Section which will solicit the input of members online to update and amplify the article. This is the way it will work. The article will be published online as well as in the Health Law Section Journal. The article (and others like it in the future) will contain an invitation for readers to e-mail corrections, amplifications or additional experiences to the Health Law Section's listserve where they will then be posted to the Health Law Section's web site along with the article. In a sense, therefore, the article will have a "pocket part" or supplement which will consist of the accumulated and pooled wisdom and experience of the thousand or so Section members who will be encouraged and invited to amplify and supplement the research and information in the article with their own considerable information and experience.

FACILITIES THAT CAN BE PUBLICLY OWNED

To begin, we will examine the smaller group of facilities: those that can be owned by public corporations. First, however some definitions and distinctions should be made. Almost all licensed entities can be owned by virtually any kind of legal entity with a couple of exceptions. The first exception is: most licensed facilities may not be owned by a corporation whose stock is then, in turn, owned by another corporation; the so-called holding company arrangement. Also, as will soon be seen, some licensees may not be owned by publicly held corporations.

However, most licensed entities may be owned by a natural person, a partnership of natural persons, a business corporation, a not-for-profit corporation or a limited liability corporation. Certain trusts can also own licensed entities and, under limited circumstances for a limited period of time, estates may operate licensed entities.

A common misconception should be cleared up. Some, who don't practice in this area, think that hospitals can only be operated by not-for-profit corporations. This is not so. Indeed, at one time there were dozens of proprietary hospitals owned by business corporations, partnerships or individuals. Inquiry by this author has revealed only the following remaining proprietary general hospitals: Long Island Medical Center (formerly Hempstead General) which is applying to change to a not-for-profit; Massapequa General, which is in bankruptcy; Brunswick Hospital Center, which is being acquired by the North Shore Hospital System; Westchester Square Medical Center and Parkway Hospital.

Hence, the common misconception that only a not-for-profit corporation can operate a hospital. In fact, the majority of hospital beds in this country are owned by not-for-profit or "voluntary" corporations; according to recent statistics, about eighty percent. In New York, the proportion is much higher. Curiously, almost the converse ratio prevails in the nursing home area where about three quarters of the beds in the country and about half of those in the State are operated by the proprietary sector and the remainder is voluntary.

We should make clear what we mean by the term "public ownership". As used in this article, it is intended to mean ownership by a publicly traded business corporation. As will be seen, this does not necessarily mean a company listed on the New York Stock Exchange but, rather, a company with a very large number of stockholders and which company needs and enjoys the necessity of a "public market" or free transferability of shares.

This is not to be confused with so-called "public hospitals" which is a term usually used to refer to those hospitals operated by special purpose not-for-profit corporations or so-called "public benefit" corporations such as the New York City Health and Hospitals Corporation, Nassau County Medical Center or Westchester County Medical Center. Another example of what is often called a "public hospital" would be the Helen Hayes Hospital and other facilities owned by governmental units of the City, State or Federal government (such as a Veterans Administration Hospital). The "publicly owned" hospitals or other licensed institutions discussed in this article are none of these.

HMO's

Health Maintenance Organizations licensed under Article 44 of the New York State Health Law may be publicly owned. There are a number of examples of these facilities such as Oxford Health Plans, Inc., and Aetna U.S. Healthcare, Inc. The licensure requirements for an HMO are not significantly different than the licensure requirements for an Article 28 licensed facility which, as will be seen, may not be owned by a public company. There is a subtle but significant difference in the wording. In Article 4401 (1) a health maintenance organization is defined as "any person, natural or corporate…." The Department of Health Office of Counsel has interpreted the language "any person" to include publicly owned companies or a corporation the stock of which may owned by a publicly owned company.

The regulations speak to this issue in a somewhat roundabout way as follows: 10 NYCRR §98-1.5(b)(3)(ii) requires disclosure on an application of sister subsidiaries owned by the applicant's "holding company" or other persons "in the holding company system". The same kind of language appears elsewhere in the required provisions in the application. Further, in 10 NYCRR §98-1.6(d) it provides that where an applicant is "controlled" the commissioner must be satisfied "that the holding company has conducted itself…." and further that in considering the application "of applicants and holding companies…." the commissioner shall consider various items including services provided by any facility "or it's holding company….". This language certainly supports the approach and present method of treatment of HMO's by the New York State regulators as entities which may be owned by public companies or, by a public company through a wholly owned New York State subsidiary.

Home Health Agencies

Home Health Agencies Licensed under Article 36 of the New York State Public Health Law can also be owned by public companies. Examples of publicly owned Home Health Agencies are National Home Health Care, Corp. Staff Builders and Olsten. Here, again there is no explicit prohibition or permission discussing or regarding ownership by public companies. The language is a little more specific than HMOs implying that ownership by a public company is permitted. For example, in 10 NYCRR §3611(1)(a) it is provided that an applicant for establishment of either a licensed home care agency or certified home health agency which will be operated by an entity (e.g. LLC or Corporation) whose members will not be natural persons or an applicant which will be operated by a corporation which has a corporate stock holder must "establish a corporation or limited liability company within the state" and such applicant must also submit for review "any parent or health related subsidiary corporation".

It should be noted that ownership by public companies is permitted of all types of home health agencies, including the so-called "nursing home without walls". This type of agency is defined in 10 NYCRR §3610 as a "long term home health care program" which may only be owned by a nursing home a hospital or a certified home health agency. A certified home health agency, according to 10 NYCRR §3611, can also be publicly owned.

Continuing Care Retirement Communities

According to the regulators, a public company can own a Continuing Care Retirement Community ("CRRC"). The law and regulations under Article 46 of the New York Public Health Law contain no limitation of ownership to "natural persons" or, of course, any specific bar on publicly traded corporations. In §4604(2)(j)(iv) which provides for issuance of a Certificate of Authority, it is stated that, amongst other disclosure information, there must be a statement as to whether the applicant or a "parent or subsidiary corporation" has been subject to certain actions. In addition in §4606(9) it is provided that in the initial disclosure statement that must be filed with the State, certain information must be disclosed "if the applicant is the subsidiary corporation or the affiliate of another corporation, as well as a statement identifying the parent corporation or other affiliate corporation…" and further "the extent to which the parent corporation will be responsible for the financial and contractual obligations of the subsidiary." If, however, an Adult Home is part of a CCRC, then public ownership would not be permitted because, as will be seen below, an Adult Home cannot be owned by a public company. The list of operational CCRCs shows most of them to be made up of a combination of Independent Living Units, Enriched Housing Units and "Nursing Home Beds". As will be seen below and as is well known, nursing homes cannot be publicly owned. None of the existing CCRCs are publicly owned. This explains how they can contain nursing home beds.

There has been very little regulatory experience in this area because of the small number of licenses so far, only five. The small number has attributed to the fact that reserve requirements for a licensed entity in §4611 are viewed as onerous by potential applicants. Indeed it is the author's experience and information from other practitioners that most of the legal effort in this area is exercised in avoiding the requirement of licensure as a CCRC while still being able to create a business that will offer the amenities of a retirement community for the elderly.

FACILITIES THAT MAY NOT BE PUBLICLY OWNED

Most institutional facilities licensed in New York may not be owned by publicly traded corporations. This is not because of any specific or clear cut prohibition (with two exceptions) but simply because of the impracticality of complying with certain licensure requirements. To be specific, the common characteristic of those facilities that may not be publicly owned is that each shareholder of such a facility applying for licensure is required to go through a "character and competence" review process by the licensing agency. A moment's thought will immediately reveal the inconsistency with this requirement and the free transferability of stock.

There is no prohibition against HCA owning a hospital in New York if each existing shareholder of HCA and anyone who wishes to buy shares from an existing shareholder submitted an application for and was approved for character and competence by the New York State Department of Health. The easy and obvious way of avoiding this problem, by having the public company set up a wholly owned subsidiary to apply for licensure, is also prohibited because of the above mentioned prohibition on the holding company or parent subsidiary arrangement. Specifically, no corporation licensed under, for example, Article 28 of the Public Health Law may have it's stock owned by another corporation.

Adult Homes

The exception to this inferential exclusion of public companies from institutional ownership is the adult home which is licensed under §461-b of the Social Services Law. Here, there is specific language prohibiting a public company from owning a facility licensed as an adult home. Until 1996, adult homes could only be owned by a "natural person or partnership composed only of natural persons or a not for profit corporation…" or various governmental type facilities. In 1996 the law was amended (laws of 1996 Chapter 543 Section 2, effective August 8^th 1996) to allow business corporations to be licensed to operate adult homes with the following specific exception for public companies "other that a corporation whose shares are traded on a national securities exchange or are regularly quoted on a national over-the-counter market or a subsidiary of such corporation or a corporation any of the stock of which is owned by another corporation, a limited liability company provided that if a limited liability company has a member that is a corporation, a limited liability company or a partnership, the shareholders of the member corporation the members of the member limited liability company, or the partners of the members partnership must be natural persons".

Assisted Living Facilities

Assisted living programs which are regulated under §461-(l) had similar language which was similarly amended at the same time (Laws 1996, Chapter 543 §5 effective August 8^th 1996) to permit business corporations other than publicly traded corporations to be licensed to operate assisted living facilities. There is some question why this limitation was imposed specifically by amendment on assisted living facilities since a requirement of an assisted living facility in §461-(l)(a), is that it must also be licensed as an adult home.

These two types of licensed facilities (the adult home and the assisted living facility) are the only facilities licensed in New York which, by their specific statutory language, may not be owned by publicly traded corporations.

Hospice

Another facility which, through the legislative language and statements by the regulators, cannot be owned by a public company is a hospice. Hospices are defined and regulated under Article 40 of the New York State Public Health Law and in §404(3)(a) it has provided that no hospice may be owned by a corporation any of the stock of which is owned by another corporation (the standard parent subsidiary prohibition). Further, the regulations in 10NYCRR §790.11 require that "only a natural person may own, hold or have the power to vote the stock in a corporation that operates a hospice." The statute also in §404(2)(b), requires that all the stock holders submit to a character and competence review.

Psychiatric Facilities

The Office of Mental Health, which regulates psychiatric hospitals under the New York State Mental Hygiene Law, has similar Certificate of Need requirements and procedures to the New York State Department of Health under Article 28 of the Public Health Law. There is the identical requirement of individual character and competence review for each shareholder. This is found in 14 NYCRR §551.7 (a)(1); §557 and §31.22 of the Mental Hygiene Law.

Most of the psychiatric beds in New York are units in Article 28 licensed general hospitals and, as such, they are licensed by both the Department of Health and Office of Mental Hygiene. There were formerly a number of "private" psychiatric hospitals which were owned by individuals or small corporations. At least two remain - Four Winds Hospital and Rye Psychiatric Institute, both in Westchester County. Another private psychiatric hospital, Holliswood Hospital in Queens, New York City, was operated and listed as one of the Hospitals owned by Mediplex, a publicly traded company about ten years ago. Upon close examination of the historical documents, it appears that this actually was a management contract relationship, about which more will be said later.

Rehab Centers

Drug and alcohol rehabilitation centers, again, appear to follow the same Certificate of Need procedure as the New York State Department of Health, however, there is much less precedent and experience here. Most of the facilities (beds and treatment slots) regulated by the Office of Alcoholism and Substance Abuse, under article 32 of the Mental Hygiene Laws are New York not-for-profit corporations. Some of the better known ones are Daytop Village and Odyssey House.

Section 32.31(c)(3) of the Mental Hygiene Law has the same provisions as §31.22(b) of the Mental Hygiene Law requiring individual character and competence review of each shareholder.

There were once a large number, and still a few remain, that are operated by individuals, partnerships or closely held corporations. There are two facilities, Conifer Park in the Albany area and Arms Acres in Carmel in Putnam County, which also were listed as being owned by Mediplex a number of years ago. The present regulators recall that those too were operated under management contracts.

Hospitals and Nursing Homes

Hospitals and nursing homes licensed under Article 28 of the Public Health law may not be publicly owned for the reasons already discussed and described, i.e., (i) each shareholder must go through character and competence review, see New York Public Health Law, §2801-a(3); 10 NYCRR §790.11 and (ii) no parent/subsidiary relationship is permitted, New York Public Health Law §2801-a(4)(e); 10 NYCRR §790.11(c)(3).

Other facilities are also licensed under Article 28 of the New York State Public Health Law. There is the generic Diagnostic and Treatment Center and then several specific types of Diagnostic and Treatment Center including ambulatory surgery facilities and dialysis centers. There have been some interesting recent developments in this area which will be discussed in more detail.

It should be noted that, at one point, the "chains" such as HCA or Humana were very interested in coming into New York and acquiring hospitals. This interest has waned with the fortunes of the chains. The nursing homes chains, such as Beverly Enterprises or Manor Care, have never evidenced significant interest in coming into New York State. This is somewhat to the dismay of a certain section of the proprietary nursing home industry. As mentioned, about half of the nursing home beds in New York are owned by proprietary corporations, usually closely held corporations. Some of the older holders of nursing home licenses have tried to encourage the interest of the nursing home chains as a "exit strategy". There has, obviously, never been any enthusiasm by the voluntary sector, either nursing home or hospital, in the entry of the Chains into New York.

In the last couple of years, publicly traded corporations have evidenced a strong interest in somehow "acquiring" New York ambulatory surgical facilities and dialysis facilities. Because of the prohibitions on direct ownership, there have been attempts to achieve this end by using management contracts and asset acquisition. These attempts have been the same approaches used by publicly traded corporations when "acquiring" physicians' practices which in most states cannot be acquired, owned or operated by a business corporation.

These approaches basically are the following: first the assets of the medical practice, or the in the case of the New York facilities, such as dialysis center or the ambulatory surgery center, are acquired. These would include the equipment, furniture and fixtures. In addition the building or the lease for the building is taken over by the "acquiring entity". The second step is to put in one or more "nominees" to hold ownership. These could be stock holders of the licensed surgi-center corporation or the dialysis center or in the case of a medical practice acquisition by a public company it would be a doctor who owns a professional corporation. These "nominees" are usually affiliated in some way with the acquiring entity, often an employee and perhaps, as well, a stock holder of the acquiring entity.

The final step is a management contract from the acquiring entity to the acquired entity or, more specifically and very often, to a successor shell corporation. The original entity having sold all of it's assets, is left simply holding cash and perhaps debt of the acquiring entity and is a non operating entity. The new entity, having applied to secure the license of the selling entity (and having it's location, assets personnel etc.) operates under the ownership of the "nominees" and pursuant to a management contract with the acquiring entity or, more usually a subsidiary of the acquiring entity.

When these contractual acquisitions started there was considerable study of the issue by the Public Health council, the State Hospital Review and Planning Council and the New York State Department of Health staff. The first result of this work was a memo by the then Counsel of the Department of Health, Henry Greenberg dated September 21, 1999. This memo basically said that these kind of acquisitions were permissible as long as the final operational decisions and some irreducible minimum of powers, something along the lines of the reserved powers of a parent or management contract powers under §405.3(f)(3) of the Health Code were respected. Because of the thoroughness of research and analysis in this memo and, as well, its broader application to, and significance for, management contract relationships generally, it is annexed as Exhibit A to this article.

There was then the study by the Representative Governance Workgroup of the Establishment Committee of the Public Health Council and the Planning Committee of the State Hospital Review and Planning Council. There was a report issued dated March 7, 2001 which basically says that this type of "acquisition" is permitted for dialysis centers but not for ambulatory surgery facilities. This report is annexed as Exhibit B.

While there's not a complete closure of the door, the requirements imposed by the Representative Governance memo has made ambulatory surgery acquisition economically unattractive. This is the result of the requirement, among other things, that all contracts with the managed Article 28 licensed entity, for example, an ambulatory surgery facility, must be at "fair market value". This makes it very difficult for the acquiring entity to get its hoped for return on investment. This, added to the considerable constraints on outside authority over operations, e.g., the requirement of majority control by persons not associated with an outside or acquiring entity, has resulted in a complete halt to, at this writing, any such applications.

Dialysis centers, on the other hand may be "acquired" and the apparent public policy reason is that, because of decreased Medicare reimbursement rates for dialysis, there are fewer interested owners in New York and it was deemed necessary to "open the gates" to public companies with their greater resources and economies of scale to "acquire" dialysis facilities in New York.

It is interesting to note that management contracts per se are only permitted for Article 28 licensed hospitals. The content and limitations of management contracts are set out in detail in 10 NYCRR §405.3(f) but they are limited to hospitals. There once were more management contracts in New York but now there are only __________ and __________ of these are between New York hospitals. In the first paragraph of Exhibit A, it is noted that the outside or acquiring entity will provide "consulting and administrative services" to the "acquired" Article 28 licensed entity. These contracts are reviewed by the State for compliance with the provisions of Exhibits A and B. These provisions are quite similar to the requirements of 10 NYCRR §405.3(f) noted above with the difference that the contracts cannot be called "management" contracts for such is permitted only for hospitals.

CONCLUSION

There is no conclusion, only a continuation of the accretion of experience and information on how these licensing laws are interpreted and administered in this State. It is believed that this State is unique in its episodic exclusion of the public companies from ownership of some, but not all, licensed facilities.

As mentioned in the early part of this article, the reader is invited to e-mail any information that could further elucidate this area for his fellow practitioners of health law to the author at rborsody@fbwhlaw.com.

Robert P. Borsody

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New York, NY 10022
Phone: 212-453-2727
Fax: 212-644-7485

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