In July of this year, the California Office of Health Care Affordability (“OHCA”) released draft regulations requiring the advance reporting of certain healthcare transactions that could affect the cost of healthcare or adversely impact the healthcare market in California. These reporting requirements implement provisions of amendments to the California Health and Safety Code enacted in 2022, which authorized OHCA to review proposed transactions and, if appropriate, undertake a detailed cost and market impact review (“CMIR”) to determine the potential impact on the health care economy of California.
Following a public workshop and comment period, OHCA released revised regulations on October 9, 2023, subject to a limited additional comment period that expired on October 17, 2023. OHCA intends to submit final regulations to the California Office of Administrative Law on an emergency basis, without further opportunity for comment, with the final regulations to be effective on January 1, 2024, and applicable to transactions closing on or after April 1, 2024.
The revised regulations clarify uncertainties created by the draft regulations. Most importantly, the trigger for the 90-day advance notice to OHCA is now based on the proposed closing date of a transaction, rather than the date when an agreement was proposed to be signed creating binding obligations. This will permit parties to a reportable transaction to fully negotiate terms (which is essential to comply with the reporting requirements) and then make the closing of the transaction contingent on completion of the review process. In addition, the financial thresholds for whether transactions are reportable were revised to state that they are based on revenue derived from California operations or assets located in California. As a result, an entity that has total revenues exceeding $25 million on a consolidated basis will not be required to report a transaction if its “California-derived revenue” from the provision of healthcare services is less than $25 million. Similarly, the asset-based tests for reporting in the revised regulations refer to assets located in California, not the total assets of an entity. The definition of entities required to report is now limited to the parties to the transaction, and not their parents or affiliates. Further, the specification of certain items required to be provided to OCHA in a report has been clarified, such as licensure disclosure, which is now limited to healthcare licenses held by the submitting party, and for only those facilities or services that are involved in the transaction.
OHCA’s revisions also somewhat narrow the scope of reportable transactions. A notable change is the elimination of management services organizations from the definition of a “Health Care Entity” which would have reporting obligations. This was a subject of considerable comment in the public workshop, as the draft regulations referred to a management services organization as a “payer.” It is still conceivable that a management services organization may be required to report transactions if it is involved in the control or governance of a Health Care Entity, which may include acting as an agent of a health care provider in contracting with payers, negotiating rates, or developing networks. The revised regulations also exclude from the definition of a reportable “Material change transaction” transactions that is in the usual and regular course of business of the health care entity or transactions in which all of the participants are under common control, such as an internal corporate restructuring. The definition of a “Transaction” has been phrased in more positive and direct terms as involving a transfer of assets, control, or responsibility for the management of assets of operations of a health care entity; the draft regulations had included more imprecise terms such as “a change, directly or indirectly” in governance or operations.
There are several provisions in the revised regulations that may cause concern for parties contemplating transactions that may be subject to reporting.
- The ten-year “lookback” requirement. In situations in which a party has been involved in a series of transactions or has engaged in one or more similar transactions, i.e., acquisition of similar healthcare entities, within the past ten years, all of those transactions will be considered as a single transaction for determining whether the reporting thresholds are triggered. This means that transactions that would otherwise not be subject to reporting and review will nonetheless trigger a compliance obligation if, the collective value of past deals exceeds the financial or control thresholds. The aggregation of transactions is not only relevant to whether a transaction is reportable but also is cited as a factor to be considered as a basis for instituting a CMIR.
- Transfer of control, responsibility, or governance. Transactions involving a transfer of control or governance are reportable, and under the revised regulation the standard for what constitutes a transfer of control or governance is (a) the acquisition of 25% or more of the voting power of an entity, including through the addition or substitution of members of a board, (b) a change in voting requirements of an entity that provides for supermajority voting or a minority veto over certain governance decisions even if the minority interest is less than 25% or (c) a transfer of 25% or more of “the administrative or operational control or governance of the management and policies of at least one entity that is a party to the transaction.” While the revised regulations increased the thresholds from 10% to 25%, this standard is still considerably below what is normally regarded as a change of control from a governance or voting perspective and could subject what are intended to be passive investments or constructive alliances, to review. It is difficult to understand what would constitute a 25% or more transfer of administrative, operational control or governance in the absence of changes in voting power or the governing board, but this apparently could reach a contractual arrangement affecting decision-making which is not generally regarded as change of control transaction in other contexts.
- Contracting entities. One of the categories of reportable transactions, relating to entities contracting on behalf of providers was substantially rewritten. The draft regulations simply referred to the creation of an entity that would negotiate or administer contracts on behalf of providers, provider groups, or ACOs. The revised regulations more explicitly identify a transaction that results in an entity contracting with payers on behalf of consolidated or combined providers and is more likely than not to increase the annual California-derived revenue of providers in the transaction by either $10 million or more or 20% or more of annual California-derived revenue at normal or stabilized levels of utilization or operation. While this change puts some financial metrics around the transaction, the two standards are not necessarily consistent and there is a question of whether the 20% increase standard could encompass relatively low revenue deals in which there is a material increase, without any particular effect on costs.
- Expedited review. The revised regulations included a new provision to permit a party to request expedited review by OHCA in circumstances where a party is under severe financial distress or there is a risk of a significant reduction in the provision of critical health care services within a geographic region or regions. Notably, this provision does not exempt such a transaction from review but rather provides that the agency, at its discretion, may truncate the normal 60-day review period (and arguably waive the 90-day advance notice requirement), if it determines that there is a basis for expedited review. This provision may have been added in response to comments at the workshop about transactions arising from bankruptcy proceedings. Unfortunately, the definition of severe financial distress as a basis for seeking expedited review refers to a substantial likelihood that a party will have to file for bankruptcy protection but does not include a situation in which a party is already in bankruptcy proceedings and seeking to arrange a transaction on an expedited basis to preserve value for creditors.
- Factors considered in determining whether to conduct a CMIR. The revised regulations have added two new matters to the scope of issues that OHCA is to consider in determining whether to conduct a CMIR, in addition to the ten-year lookback provisions described above. These are (a) whether the transaction “may lessen competition for workers or may negatively impact the labor market,” and (b) whether a transaction involving an out-of-state party may negatively impact affordability, quality, or access to health care services in California or undermine the financial stability or competitive effectiveness of a health care entity located in California. The former provision seems related to comments by organized labor representatives at the workshop about the impact of certain transactions on wages or employment. The latter criterion is partially a refinement of what was simply a cost and access consideration but also has elements that could be interpreted as protection of actual or potential competitors rather than the competitive landscape. In the provisions describing the factors to be considered in a CMIR, these latter two considerations are echoed, although the factor relating to competitive effects is phrased in the more typical language of foreclosing competitors and creating barriers to entry rather than the effect on existing competitors in a market.
- Independent authority to conduct CMIR. A new provision in the revised regulations states that nothing in the regulations precludes OHCA from conducting a CMIR at the request of its Director pursuant to the Health and Safety Code. This authority could reach transactions not otherwise subject to review or independent determinations by the Director to investigate market conditions. It is not clear why OHCA felt this was necessary given the existing statutory authority of OHCA.
- Filing requirements. The required contents in a notice filing have been enhanced to include descriptions of all entities involved in the transaction (and whether such entities are also submitting filings) which should include (a) additional information concerning revenues (prior 3 years where the draft regulations required only current year revenues), (b) primary and threshold languages used in providing services and (c) in the case of a merger or acquisition descriptions of any prior merges or acquisitions involving the same or related health care services which involved an party to the transaction or their parents, subsidiaries, predecessors or successors in the proposed transaction within the prior ten years. In addition, the submission package must include any Premerger Notification and Report Form and attachments filed in accordance with the Hart-Scott-Rodino Act, documentation relating to the valuation of the transaction and existing documentation related to the valuation of the transaction, and documentation identifying the number of patients per zip code or enrollees per zip code in the last year.
- Definitional Issues. The revised regulations continued the inclusion of the term “encumber” in the definition of “transaction” which means that a traditional bank loan to a healthcare entity, in which at least 25% of its assets may be subject to pledges or liens may become a reportable transaction. It may be that a refinancing of existing debt will be exempt under the “usual and regular course of business” exception noted above, but this may not apply in the case of a new financing transaction. The definition of “revenue” has been modified by the phrase “as it was generated or occurred in California, rather than when revenue is booked, accrued or taxed.” It is not clear whether this change will require special accounting processes as it appears to require disregard of customary year-end adjustments, accruals, or timing considerations. The draft regulations included an undefined term “certified financial statements” as one of the requirements for a notice filing. The revised regulations have added a definition, which includes audited financial reports. For entities that do have audited financials, the required submission must be a “comprehensive financial statement” with substantial detail, which must be accompanied by a sworn written declaration by the chief financial officer, chief executive officer, or other officer with responsibility for financial management and oversight that the financial statements are true and correct in all material matters, that the entity does not routinely prepare audited financial statements and that the revenue calculations for the entity conform to the definition of revenue described above. Putting aside that the language of the revised regulations does mirror customary accounting language for financial statements, the requirements may prove very daunting for entities that do not typically have audited financials.
The revised regulations, while incorporating useful improvements in the regulatory scheme, also significantly expand the scope of OHCA’s authority over transactions involving healthcare entities and will increase the reporting burdens for entities proposing to engage in reportable transactions. It remains to be seen whether OHCA’s review process will work efficiently and whether it will result in a substantial number of CMIRs and consequent delays in the closing of transactions or in some cases abandonment of deals.