Stark Law Final Rule – Impacts on Health Care Leasing Arrangements
Hall Render attorneys from four offices across the U.S. discuss CMS’ Final Rule modifying various Stark Law regulations, including those specifically geared toward health care real estate arrangements. CMS issued the Final Rule on November 20, 2020, and starting January 19, 2021, health care organizations nationwide were required to comply with the new regulations. The podcast discussion addresses key guidance provided by the Final Rule, and covers topics of fair market value, commercial reasonableness, and Stark exceptions that may be available to health care organizations.
Attorney, Hall Render
Attorney, Hall Render
Attorney, Hall Render
Attorney, Hall Render
Libby Park: Hello, everyone. And welcome to the Healthcare Real Estate Advisor podcast. My name is Libby Park and I’m an attorney with Hall Render, the largest healthcare focused law firm in the United States. Thanks for tuning in today. We have some great content for you. Today, we’ll be talking about CMS’s final rule aimed at modernizing key fraud and abuse regulations under the Federal Stark Law. CMS issued the final rule in November, 2020, which became effective as of January 19th, 2021. These regulations have now been in effect for a few weeks. So, we hope that this podcast has content that is relevant and timely to our listeners. Today, we’ll hear from three Hall Render attorneys from different geographic locations around the U.S. Joel Swider is joining us from our Indianapolis office. Hi there, Joel.
Joel Swider: Hi, Libby. Thanks for having me.
Libby Park: Of course, welcome. Kiel Zillmer is based out of our Milwaukee office. Hi, Kiel.
Kiel Zillmer: Hi, Libby.
Libby Park: And Gerard Faulkner is from our Dallas office. Hey, Gerard.
Gerard Faulkner: Hey, Libby. Happy to be here.
Libby Park: Thanks for joining us. I’ll be moderating our conversation today, and I’m located in Hall Render’s Denver office. Thanks, everyone, for joining me today. Today, we’ll discuss the big three areas of the Stark law final rule changes that will impact healthcare leases, fair market value, commercial reasonableness, and exclusive use. Joel, let’s start our conversation with fair market value, as it relates to the final rule. Can you tell us what changes did CMS make to its interpretation of fair market value in the real estate context?
Joel Swider: Thanks, Libby. When it comes to fair market value, CMS did a couple of things in the final rule. The first is that they finalized changes to the structure of the definition of fair market value, the structure itself. CMS advanced a general definition of fair market value, as well as some more specific definitions that apply in the rental of office space and rental of equipment contexts. The general definition of fair market value that was finalized is, and I’m quoting here, “The value in an arm’s length transaction, consistent with the general market value of the subject transaction.” So, they’ve really scaled it back and made it more basic.
Joel Swider: And then, CMS went on to give additional definitions for, in our context, the rental of equipment and the rental of office space. And so, part of that definition, from the rental of office space exception or the new language from the final rule says, “With respect to the rental of office space, fair market value means,” and I’m quoting here, “the value in an arm’s length transaction of rental property for general commercial purposes, not taking into account its intended use, without adjustment to reflect the value that the perspective lessee or lessor would attribute to the proximity of convenience to the lessor where the lessor is a potential source of patient referrals.” So, this was a concept that appeared previously, but was somewhat disjointed and they kind of brought it down into one definition.
Joel Swider: And then, furthermore, and I’m quoting again here, it says, “It must be consistent with the general market value of the subject transaction.” So, the CMS also updated the definition of general market value to sort of bifurcate it into multiple parts, applicable to different scenarios and applications. They had one part for assets, one part for compensation, and there’s a separate definition for general market value that is specific to the rental of office space and equipment. And what CMS finalized there is, it says, “With respect to the rental of equipment or the rental of office space, the general market value is the price that rental property would bring at the time that the parties enter into the rental arrangement, as the result of bonafide bargaining between a well-informed lessor and lessee that are not otherwise in a position to generate business for one another.”
Joel Swider: So, these concepts in verbiage are really consistent with how those definitions read in the past. But they’ve been consolidated and they’re easier to find. And so, really to my mind, from a practical perspective, I don’t know that this necessarily changes the end result of what would be considered fair market value. But I do think that it makes it easier for a health provider to find and use the definitions. It also makes it easier when we are, let’s say, reviewing an appraisal that has come in from a third party. We can make sure that they’re using the right definitions and that they’re using them in the right contexts.
Joel Swider: So, the other thing that I’ll mention about the fair market value definitions for real estate arrangements was CMS removed part of the text that used to say a rental payment does not take into account intended use if it takes into account the costs incurred by the lessor in developing or upgrading the property. And CMS had originally added this language to the Stark regulations to basically clarify that rental payments may reflect, they are allowed to reflect the value of improvements or amenities, which I think to most of us practicing in the real estate realm or anybody that’s an appraiser or works with valuations frequently would realize that that is a base assumption upon which the fair market value of the space is based, is those costs that were incurred in improving it. But CMS basically said this was really confusing to people. It wasn’t necessary. And so, they took it out.
Joel Swider: So, I guess, in summary, the CMS in the final rule, they modified that definition of general market value to more closely align with valuation principles that are already used. And any sort of FMV appraisal or broker’s opinion of value that a provider might have previously used is probably still accurate, even if it’s based on those old definitions. But, from a practical matter, I think one takeaway for me and to those listening is, consider updating your template fair market value reports, your fair market value policies, your lease templates, because these definitions have changed. And to the extent that an appraiser would, in his or her professional judgment, base an opinion on these, obviously they’re going to be very important for those purposes.
Libby Park: Thank you, Joel. And thanks for offering some practical tips for folks listening in as to how we can apply some of these changes. Another question, in regard to fair market value, Joel, did CMS opine on any methodologies for setting FMV in real estate transactions?
Joel Swider: They did. So, what CMS said in terms of methodologies was basically that CMS will not prescribe any particular method for coming up with fair market value. And CMS said it would accept a range of methods, appraisals, comparables, looking at documentation of other transactions. They even talked about cost plus a reasonable rate of return, which is something that hasn’t appeared in commentary for a long time. Basically they will accept any method that’s reasonable.
Joel Swider: And I think, from a practical perspective, this really gives providers a bit more leeway to use their discretion, which is a good thing for providers. And I think that’s where too, from a legal perspective, some of our guidance comes in the form of let’s look at this arrangement, let’s look at the stakes involved and the parties involved. And maybe we can apply a cheaper, or faster, or easier method to come up with fair market value, as opposed to getting an appraisal, which is really sort of the gold standard. And that’s something that you would want to use in a more high-risk type of arrangement. So, I think in general though, it was good because CMS gave additional leeway to providers in this area.
Libby Park: Thank you, Joel. Appreciate your thoughts on the fair market value portion of this. Let’s shift to commercial reasonableness. Gerard, can you please tell us a little bit about what changes did CMS make to the definition of commercially reasonable?
Gerard Faulkner: Yeah. So, CMS’s definition of commercially reasonable was sort of expanded in order for them to try and take a more objective approach to their analysis. And so, they ended landing in the final rule on commercially reasonable meaning that the particular arrangement furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty. CMS also kind of added in there that an arrangement may be commercially reasonable, even if it does not result in profit for one or more of the parties.
Libby Park: Gerard, thanks for that definition. How will CMS determine if an arrangement is commercially reasonable? And how does the new definition impact this analysis?
Gerard Faulkner: So, now under the final rule, the new rule, CMS’s determination is based on a case by case analysis that turns on whether or not the arrangement makes sense as a means to accomplish the party’s legitimate business goals. And so, when CMS is making this determination, they’re going to look on a case by case fact specific inquiry on the characteristics of the parties. And that will kind of depend on which parties are involved. So, they’re going to be looking at things like the size, the type, and scope and specialty of the parties.
Gerard Faulkner: CMS indicated in the publishing of the final rule that it views this updated standard is more objective since it requires assessment of the characteristics of the parties themselves rather than the previous rule, which had more of a focus only on the perspective of those parties as they entered the arrangement. So, that’s really how the previous CMS commentary had framed this commercial reasonableness discussion. It’s important to remember though that just because an arrangement ultimately achieved a legitimate business purpose, that doesn’t mean that that arrangement was necessarily commercially reasonable. We can take from the final rule that the focus here will not, obviously, be on that result of the arrangement, and moreso a fact-based inquiry, case by case inquiry into whether or not it was reasonable to enter that arrangement in the first place for the parties.
Libby Park: Thanks for those thoughts, Gerard. And can you tell us how will this definition, what are your thoughts on how the definition of commercially reasonable will work in conjunction with the requirement that lease space does not exceed the amount of space that is reasonable and necessary for the legitimate business purposes of the leasing arrangement?
Gerard Faulkner: Yeah. So, that’s a bit of a mouthful, but CMS essentially clarified the additional requirement that the leased space does not exceed that which is reasonable and necessary for the legitimate business purposes of the lease arrangement. In the office space exception, it’s separate entirely from this commercial reasonableness standard. According to CMS, the language in that office space exception is more geared towards the prevention of sham lease arrangements where the rental charges are for office space for which the lessee rather has no genuine or reasonable use. So, it’s not serving legitimate business purpose.
Libby Park: Great. Thank you for your thoughts on this topic, Gerard. Kiel, let’s close things out today with a discussion on the changes to the rental of office space exception. Did CMS make any other noteworthy adjustments to the rental of office space exception that providers should be aware of?
Kiel Zillmer: Thanks Libby. Yes. In addition to the changes to FMV and commercial reasonableness that Joel and Gerard have discussed, CMS finalized another significant change to the rental of office space exception and how we view leasing arrangements in the healthcare context. One of the requirements of the rental of office space exception is that the lease space be used exclusively by the tenant. The rationale for this requirement was to prevent, as Gerardo alluded to previously, sham or paper leases in this case where a landlord receives payment from a tenant for space that the landlord continues to use itself. However, without further clarification, this requirement was also interpreted to mean that the tenant could not share the space with other tenants contemporaneously. So, when we had clients who wanted to structure part-time or shared space arrangements, we were inclined to rely on the timeshare exception to protect the arrangement, which does permit non-exclusive use. But, as those who work with the timeshare exception know, it does have a number of strings attached to it and a number of hoops to jump through.
Kiel Zillmer: In the final rule, CMS incorporated a comment in the rental of office space exception, which clarifies that the exclusive use, as used in the exception, means that the tenant and any other tenants of the same space uses the space exclusion of the landlord or any person or entity related to the landlord. So, in other words, the landlord may not be an invitee of the tenant to use a space, but the tenant and any other tenant operating in the same space may use it at the same time. So, this is a significant clarification by CMS, particularly in light of the trend of hospitals employing more physicians, as value-based healthcare becomes more prevalent. It allows for greater flexibility in how leasing arrangements can be set up, and provides more collaboration between tenants in clinical space.
Kiel Zillmer: So, a prime example of the situation would be where a physician invites another physician into its clinical space to treat a mutual patient for the patient’s convenience. This may have previously been considered a Stark violation, given our understanding of the rental of office space exception and the exclusive use requirement. However, with the revisions to the exception, CMS has made it clear that these types of arrangements would not pose a risk of program or patient abuse, provided that they continue to meet the other requirements of the rental of office space exception. And lastly, I should also mention that CMS also incorporated a similar change to the exclusive use requirement in the rental of equipment exception. So, there is some additional leeway there as well.
Libby Park: Thanks, Kiel. It sounds like the final rule added in some flexibility, which will be beneficial to providers and further clarification as well. Another question, does the final rule provide any other insight on Stark exceptions that may be available to providers in structuring real estate arrangements?
Kiel Zillmer: Yes. As I mentioned, when we look at protecting real estate leasing arrangements, we have typically looked at the rental of office space and timeshare exceptions. However, in the final rule, CMS made clear that leasing arrangements may also be protected under the fair market value exception. But this is also a drastic departure from CMS’s position in previous rulemaking and is significant, particularly in light of the fact that the fair market value exception does not have a one-year term requirement like the rental office space exception does. This provides healthcare entities with greater flexibility for one-off arrangements that may be shorter than one year or arrangements that otherwise do not qualify under the rental of office space or timeshare exceptions.
Kiel Zillmer: In the final rule, CMS also confirmed its position that other exceptions, even beyond the rental of office space and fair market value exceptions, may protect space lease arrangements. For example, CMS reiterated that the arrangements with hospitals exception could cover certain real estate arrangements like, for example, rental payments made by a teaching hospital to a physician to rent his or her house, as a residence for a visiting faculty member. Likewise, CMS repeated that the payments by a physician exception could protect payments by a physician for the lease or use of space other than office space, such as for leases of hospital owned storage space or residential real estate.
Kiel Zillmer: And finally CMS finalized this proposal for a new exception for arrangements with limited remuneration. Provided certain requirements are satisfied, this exception would protect remuneration from an entity to a physician for the provision of items or services that does not exceed $5,000 per calendar year. So, this exception could be available to protect one-off or short-term lease arrangements with terms that are set in advance, even if the arrangement is not set in writing, that is not a requirement under this exception. So, obviously, it provides some greater flexibility there as well.
Kiel Zillmer: And lastly, I just wanted to mention two other changes CMS made that could also be relevant for those who practice in the healthcare real estate realm. First, CMS revised its position with regard to missing signatures and the writing requirement rules. Previously, if a written agreement lacked the party’s signatures, they were allowed to obtain the signatures within 90 calendar days following the effective date of the arrangement, provided the arrangement complied with all other required elements of an applicable exception. In the final rule, CMS expanded the scope of the late signature exception to include a grace period for the required writing, along with the missing signatures. In the event the parties fail to compile a written agreement for a particular arrangement, if that’s a requirement under the applicable exception, they now have 90 days from the arrangement’s effective date to compile a collection of documents that evidences the course of conduct and the terms of the arrangement between the parties and reduce that collection to assigned writing. So, we’re expanding it, not just to the signature, but also to the required writing requirements for certain exceptions under the Stark.
Kiel Zillmer: The second change is with regard to the isolated transaction exception. Healthcare entities have historically used this exception to protect a one-time transaction involving a single payment or one that involves integrally related installment payments. In the leasing context, we typically see this exception called upon in the instance of a missed rental payment or a similar oversight in an arrangement. But the final rule clarifies that the forgiveness of an amount owed in settlement of a dispute, so for example, the payment of back rent or a missed rental payment, is itself a separate arrangement which may be covered under the exception. However, the important thing to note here is that the compensation arrangement, which is the subject of the underlying dispute, is not retroactively made compliant simply because a settlement arrangement is achieved by the isolated transaction exception.
Kiel Zillmer: So, it gets to be a little complicated and convoluted when you go down this path of trying to figure out if an arrangement or a back payment could fit under the isolated transaction exception. So, if there is any confusion or any question as to whether an arrangement would comply with the exception, we often tell our clients to go through the facts and consult with their attorney to figure out if they can rely on the exception in that case.
Joel Swider: Yeah. And, Libby, this is Joel. The only thing that I would add there, and I think Kiel makes a great point, that these additional exceptions that CMS has allowed providers to avail themselves of in the leasing context is a really big and important departure from past guidance, and one that I think a lot of our health provider clients will be able to utilize.
Joel Swider: So, I guess, two quick notes. One is on the isolated transactions exception. As Kiel noted. I mean, I think the important thing to consider there is that CMS didn’t have a lot of guidance on that particular exception in the past. And so, one of the big, I guess, departures or clarifications that was made was the fact that it doesn’t make the underlying arrangement compliant. And Kiel noted this, but I just want to highlight that, that even if we have a payment that needs to be made to settle a dispute, that payment itself might qualify or be compliant under the isolated transactions exception, but it does not make the underlying arrangement compliant, if it otherwise wasn’t, otherwise didn’t meet the other standards.
Joel Swider: The other thing I wanted to point out too is the fair market value exception, because I think that that one, in particular of all of the three or four that CMS pointed out and sort of opened up to leasing arrangements, I think the fair market value exception is going to be really important and provide a lot of flexibility to providers because it can sort of help cure or cover arrangements that, as Kiel noted, they maybe don’t fit within the realm of office space exception. Maybe the term is less than a year. And they maybe don’t fit in the timeshare exception, because it’s actually a lease. It’s not a license. It’s conveying a possessory leasehold interest. But nonetheless, it can meet the other elements of the fair market value exception and, in some ways, that might be easier for certain arrangements. So, I think that’s another one that I think it provides a really good backstop for providers who are really trying to do the right thing with their arrangements, but for whatever reason, the terms of that arrangement don’t fall neatly into the rental of office space exception.
Libby Park: Thanks for jumping in, Joel, and for those additional thoughts on the two exceptions and highlighting their relevance to our listeners today. That’s all that we have on our discussion format for today. Thanks to all of our listeners for tuning in and to Joel, Gerard, and Kiel for joining me today. Please feel free to email any of us directly with follow-up questions. Our emails and contact information is located in the show notes of this podcast and also on Hall Render’s website at www.HallRender.com. And additionally, I’d let listeners know that we prepare a newsletter called the Healthcare Real Estate Advisor. And, to be added to this list, please email me directly at LPark@hallrender.com. Thanks again for tuning in, and have a great day.