In many ways, ambulatory surgery centers (ASCs) are like living organisms that pass through “life cycles,” as clinics’ investor bases age, relocate and otherwise change. Consequently, it is essential that centers constantly be on the alert for ways to add new and productive investors.
It has been our experience, however, that many centers get ahead of themselves when attempting to add new investors. Crucial contractual and legal requirements are frequently overlooked in the rush to add “fresh blood.” The purpose of this article is to highlight some of the issues that centers seeking to add physician investors should consider when recruiting new partners. It is hoped that this brief article can make the recruitment process more “seamless.”
Securities Law Considerations
Centers often forget that the units of limited liability company or partnership interests which they sell to new investors will likely constitute “securities” under federal and state law. A maxim that centers should keep in mind is that the sale of all securities must be registered with the federal and state authorities unless there is an exception available. Fortunately, the sale of interests to a few physician investors as part of the periodic addition of new investors will very likely be covered by federal and state exemptions from registrations applicable to private offerings.
Despite the fact that a center may not be required to register the sale of units to new investors, the securities laws will still impose certain disclosure requirements when such sales are made. The extent of the disclosure requirements for any limited offering will depend upon the circumstances in each case. Particular attention should be paid to the number of offerees involved and the financial means of the individuals to whom the units are offered. For example, if units are being offered to individuals who meet the definition of “accredited investors,” under the federal securities laws (e.g., those having a net worth of more than $1 million or earning annual incomes of greater than $200,000) the disclosure requirements for such a private offering will be considerably less than those in offerings made to a considerable number of offerees (e.g., 15) who did not all constitute accredited investors. The failure to provide the appropriate level of disclosure when units are sold could expose the center’s governing body to liability, and could permit a disgruntled investor to recoup his investment with interest.
Even though a lower level of disclosure will be required in those instances where sales are made to a small number of accredited investors, we always encourage our clients to provide as much disclosure as can reasonably and expeditiously be gathered under the circumstances. For example, at a minimum, we suggest that our clients provide to prospective new investors the most recent financial statements for the center (whether unaudited or audited), the governing documents for the center (e.g., the operating agreement or partnership agreement), a letter describing the status of the center’s operations (the size of the center, the number of other partners, and specialties offered), and a description of any particularly material item(s) that the center and its counsel feel the investor must know. Such material information could include litigation that the center is in or may become engaged in, the status of the center’s managed care contracts or transactions that the center maintains with current members in the center (e.g., the facility lease relationship). Given the importance of securities law considerations, generally, we strongly advise centers to consult with their counsel when issuing units.
State Change of Control Issues
The addition of investors to a center could trigger significant reporting obligations for the center that it must meet in order to protect its certifications or licenses with the federal and state authorities. Under certain circumstances, the addition of new participants in an ASC project could be deemed to cause a change of control (CHOW), as defined by the Centers for Medicare & Medicaid Services (CMS). The significance of a CHOW is that the center may be required to apply for a new Medicare number and hold Medicare claims until such a number has been issued. While it is unlikely that the purchase of interests by a few additional investors directly into a center will trigger a CHOW under federal regulations, the need to notify federal and state governments may be required. Consequently, when selling units to new investors, centers should consult with their counsel to determine whether a CHOW might be triggered or whether there is a requirement to notify the authorities concerning the sales.
Contractual Obligations Applicable to Additional Investors
Above, we discussed internal contractual considerations centers should consider as they recruit new investors. It is also crucial that centers determine whether any prospective new investors are themselves subject to contractual obligations to other entities that may complicate or prohibit altogether an investment in the center. The governing documents for many centers contain covenants that prohibit their members from owning interests in competing facilities within a specified geographic area. When evaluating a new member, it is essential that the center asks such investor whether he or she is currently an investor in another project and, if so, whether the governing documents of that project contain a covenant prohibiting investment in other entities. If it is determined that the prospective investor is a participant in another project, the center seeking to recruit him or her for its own project should obtain some sort of assurance from the prospective investor’s counsel that he or she is not prohibited from participating in the center. We generally discourage our center clients from obtaining the governing documents of another project for purposes of determining if an investment is feasible, since doing so could expose a recruiting center to claims of tortious interference with the operations of the other potentially competitive project.
Preparing for and welcoming new investors will be a crucial and ongoing process for any center. By taking the time to prepare for and properly structure the transaction, including the review and implementation as required of the items set forth above, a center can better assure an efficient and positive start to its business relationship with its new investors.
Lorin E. Patterson, JD, partner with Reed Smith LLP, practices business, corporate, commercial and securities law, with an emphasis on healthcare joint venture formation, planning and development. He can be reached at LPatterson@ReedSmith.com.
Jeffrey L. Heninger is an associate with Reed Smith and practices healthcare regulatory law. He can be reached at JHeninger@ReedSmith.com.
To read Part I of this article, click HERE.