Fraud and Abuse Compliance Review No. 2: Fair Market Value and Commercially Reasonable

(Author’s/Editor’s note: This will be a series of articles addressing Fraud & Abuse)

Every financial relationship a hospital has with a physician or physician owned entity must be reviewed and structured to ensure it complies with the Physician Self-Referral Law, 42 U.S.C. § 1395nn (Stark II) and the Federal Anti-Kickback Statute, 42 U.S.C. § 1320a-7b(b). Compliance must be and remain a central focus of any healthcare entity as it is virtually impossible to cure violations of the fraud and abuse laws and each violation can subject the parties to criminal charges and civil monetary penalties that can quickly bankrupt the parties. Moreover, through the March 23, 2010 PPACA and recent changes to the False Claims Act, Congress has increased provider’s compliance obligations and made it easier for parties to institute False Claims Act law suits.

As the second in a series of articles summarizing the fraud and abuse issues typically faced by hospitals, this article will focus on a summary of two key compliance concepts: Fair Market Value and Commercially Reasonable. These two concepts form the bedrock of the fraud and abuse statutes and regulations hospitals face every day. As the Federal government continues to increase its healthcare fraud and abuse enforcement as a means of funding healthcare reform, it is crucial for hospitals to have a clear understanding of these two lynchpins of compliance.

I. Fair Market Value

Fair Market Value, the central feature of most of the Stark II exceptions and Anti-Kickback Safe Harbors, is defined as:

the value in arm’s-length transactions, consistent with the price that an asset would bring as a result of a bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party.

This definition is in keeping with the overarching purpose of the fraud and abuse statutes: to remove financial incentives from the medical care decision making process. For instance, a hospital may lease space in a medical office building to a physician; however, the hospital must charge that physician a rental rate that is consistent with the fair market value of the space. The rental rate must be the same as the hospital would charge a non-referral source or that a non-health care landlord would charge the physician for the space. The purpose is to prevent hospitals from leasing space to physicians at reduced rates in order to induce the physician to locate by the hospital and refer patients to the hospital.

It is important for hospitals to review their financial arrangements with physicians and other referral sources to ensure that the compensation paid under these arrangements is pursuant to a written agreement that meets the conditions of the relevant Stark II Exception and is consistent with fair market value.

II. Commercially Reasonable

Far too often, providers are under the mistaken impression that as long as an arrangement with a physician is consistent with fair market value, that they have met the applicable exception or safe harbor requirements. However, Commercially Reasonable is a corollary to the requirement that compensation paid be fair market value and is a distinct and separate requirement that must be evaluated on its own.

For instance, the Equipment Rental exception to Stark II requires the parties to ensure that the “equipment rented or leased does not exceed that which is reasonable and necessary for the legitimate business purposes of the lease or rental” and that the “agreement would be commercially reasonable even if no referrals were made between the parties.” 42 CFR § 411.357(b). Parallel requirements exist for space leases, employee contracts, personal services arrangements and other financial relationships with physicians.

The commercially reasonable requirement must be understood as a separate limitation on financial arrangements. In the context of a medical director, a hospital may decide that it needs a medical director of pulmonology. In the course of its due diligence, the hospital estimates that the medical director’s duties will take a physician approximately 10 hours per month and that the Fair Market Value for such administrative services is approximately $150 per hour. The hospital cannot use this as justification to establish a closer relationship with an important area pulmonologist by offering the pulmonologist a medical director agreement that will pay the physician $150 per hour for 20 hours per month. While the compensation would be fair market value, it would no longer be commercially reasonable since the amount of hours contracted for are double what the hospital actually needs.

Consequently, as part of a hospital’s compliance review, each financial arrangement with a physician or other referral source needs to be reviewed to ensure it is commercially reasonable. The hospital’s need for the equipment rented from a physician or the number of hours it takes to complete an employee’s or medical director’s duties, etc. must be documented. The risks posed by the current fraud and abuse laws and the significant financial, administrative and criminal penalties associated with violations of these laws, necessitates a thorough and careful review of these arrangements.

“Fraud and Abuse Compliance Review No. 2: Fair Market Value and Commercially Reasonable.”

Louisiana Hospital Association Impact Law brief, Vol. 25, (No.7). July 30, 2010

Michael R. Schulze