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PRRB Reverses Intermediary's Disallowance for Related Party Transaction of Loss on Sale of Assets of Hospital

 
 

HLD, v. 28, n. 7 (July 2000)

PRRB Reverses Intermediary's Disallowance for Related Party Transaction of Loss on Sale of Assets of Hospital

North Iowa Medical Center ("Provider"), a general short-term acute care hospital in Mason City, Iowa, sold substantially all of its assets to a multi-state healthcare system, North Iowa Mercy Health Center, Inc. ("Buyer"), which, through an unincorporated subsidiary, operated a general short-term acute care hospital that competed locally with Provider. In its final cost report, Provider claimed a loss on the sale of its assets. Provider's fiscal Intermediary ("Intermediary") rejected Provider's claimed loss on sale (with an amount in controversy of $3,256,187) on the basis that the sale had taken place between related parties. Provider appealed.

In a decision with implications for related party cases generally, the Provider Reimbursement Review Board ("Board") rejected the Intermediary's claim that the parties had been related. Provider and Buyer were unrelated before negotiations regarding the possible sale of Provider to Buyer. On November 19, 1992, Provider and Buyer entered into a memorandum of understanding ("MOU") in which Provider and Buyer agreed to work towards a "'legal consolidation.'" According to the MOU, Provider and Buyer intended to form a new corporation that would run Provider's operations and Buyer's local hospital operations. The MOU provided that Provider's foundation, a wholly owned subsidiary of Provider, would be a Class A member of the new corporation with an approximately 19% interest in the residual assets of the new corporation in the event of its dissolution and that the powers of Provider's foundation would be limited solely to protecting its interest in the residual assets of the new corporation upon dissolution. Buyer retained substantial control over the new corporation as its Class B and only other member.

On June 11, 1993, several months after having entered into the MOU, Provider and the new corporation entered into a purchase agreement in which Provider agreed to sell substantially all of its assets to the new corporation. As consideration for the assets, the new corporation agreed to assume liabilities of Provider totaling approximately $7 million, but paid no cash consideration to Provider.

Following the transaction, Provider's former president served as an executive vice president and chief regional systems officer of the new corporation. In addition, two weeks after the sale, Buyer, as the Class B member of the new corporation, appointed four members of Provider's former board of trustees to be members of the eighteen-member board of trustees of the new corporation.

The Intermediary made numerous arguments in support of its claim that the sales transaction had occurred between related parties, all of which the Board rejected. The most significant among these arguments was that the execution of the purchase agreement had caused the parties to become related on the basis of the principles articulated in Provider Reimbursement Manual ("PRM") � 1011.1 and Health Care Financing Administration ("HCFA") Ruling 80-4. The fundamental premise of that authority is that otherwise unrelated parties may become related by virtue of the rights created by the contract at issue. The intermediary based its argument on two facts. First, it cited the continuity of control that allegedly existed between Provider and the new corporation as a result of four members of Provider's former board of trustees becoming members of the new corporation's board of trustees. Second, the intermediary pointed to the relationship of Provider's foundation to both Provider and the new corporation both before and after consummation of the purchase.

Although the Board reiterated its agreement with the general principle that the absence of a relationship before a merger does not preclude a finding of relatedness for purposes of applying the Medicare related organization rules, it also concluded that application of that principle in this context was improper. In rejecting this argument, the Board first noted that the foundation existed primarily to raise funds from the community and had only very limited powers with respect to the new corporation. Second, and more significant with respect to related party transactions generally, the Board held that, although four members of an eighteen-member board of directors are not "without influence," the "degree to which that influence exists is less than is needed to 'direct' the actions of the corporation." In other words, "the Board does not believe that four members of an eighteen member Board of Directors has the power to significantly influence or direct the actions or policies of a corporation."

Finally, the Board concluded that the overlapping board members' control over the new corporation's actions or policies after the merger had "little or no relevancy" given that their appointment did not occur until two weeks after consummation of the merger. Accordingly, those Board members had no opportunity to affect the purchase agreement that had been already executed or the purchase price that had already been fixed at the time of their appointment.

The Intermediary also argued that Provider and the new corporation were related as a result of the MOU because the MOU provided that Provider's foundation would be the Class A member of the new corporation. The Board rejected this claim on the basis that the MOU was not a legally binding document, but merely an expression of the parties' mutual intentions to continue negotiations.

The Intermediary further argued that the new corporation's certificate of incorporation, filed February 18, 1993, supports its related party determination because the certificate (1) established Provider's foundation as the Class A member of the new corporation with rights to a minority interest in the residual assets of the new corporation upon dissolution and (2) named four members of Provider's board of trustees to be members of the new corporation's board of trustees. The Board rejected this claim, noting that the foundation was not an owner of the new corporation or its assets. The Board found that the new corporation was merely a shell with no operations or assets at the time the certificate was filed and was only standing by to receive Provider's assets when, and if, the real parties to the negotiations reached and executed definitive purchase agreements. The Board determined that the real parties to the negotiations at the time were Provider, Buyer, and Buyer's unincorporated subsidiary that operated the hospital competing with Provider. The Board also found that naming individuals to the board of trustees of the new corporation, a non-operating corporation at the time, did not reflect an affiliation or allow Provider to exercise control over the new corporation.

Finally, the Intermediary argued that its position was supported by the minutes of a meeting of Provider's board of trustees that indicated a change in the structure of the proposed transaction from a consolidation to a purchase of assets to take advantage of favorable Medicare reimbursement treatment. The Board dismissed this argument on the basis that it was not sufficiently developed by the intermediary.

Thus, the Board ruled that the Purchase Agreement was not a related party transaction and that Provider's claim for a loss on the sale of its assets was proper.

North Iowa Medical Center (Mason City, Iowa) v. Blue Cross and Blue Shield Ass'n/Wellmark, Inc., PRRB Hearing Decision No. 2000-D52 (P.R.R.B. Dec. 2, 1999) (19 pages).

Health Lawyers thanks William S. Hammond, now of Nuyen Tomtishen & Aoun, P.C., Northville, Michigan, one of the attorneys who represented the provider while he was with Honigman Miller Schwartz and Cohn, in Detroit, Michigan, for providing the above summary and Leslie Demaree Goldsmith, of Ober, Kaler, Grimes & Shriver, in Baltimore, Maryland, for contributing to the above summary.

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