On November 28, 2023, the California Office of Health Care Affordability (“OHCA”) submitted proposed emergency regulations (the “Regulations”) on the reporting of certain transactions involving health care entities for review by the California Office of Administrative Law, the final step in the regulation process. The final Regulations, reflecting changes in response to public comments and those proposed by the Office of Administrative Law, were released on December 18, 2023, and will apply as of January 1, 2024, to covered transactions with a proposed closing date on or after April 1, 2024. Earlier articles covered the draft regulations and revised regulations, which parallels similar reporting regulations in nine other states, including Massachusetts, Washington, and Oregon. New York is proposing similar regulations for adoption in 2024.
This article will comment on the most recent changes to the Regulations and certain practical issues that must be considered in future transactions that will be subject to the reporting regime and cost and market impact reviews (“CMIR”).
Key Changes in the Final Regulations
The final Regulations have been modified to limit the entities required to report as well as certain transactions that are subject to reporting. As previously noted, the obligation to report a transaction is based on two factors—whether a party is a health care entity meeting certain criteria and whether the transaction itself constitutes a “material change transaction.” It is important to note that in certain instances, such as a transaction involving a physician group with fewer than 25 physicians or a party with less than $10 million in California assets or California-derived revenues, one party to the transaction may not be required to file a report with OHCA, even though the transaction itself is reportable by the other party or parties to the transaction.
The Regulations were revised to eliminate a previous provision that included management services organizations (“MSOs”) as health care entities required to report, in response to extensive comments. A transaction involving an MSO may be subject to reporting requirements if the MSO’s functions include contracting with payers on behalf of a group of consolidated or combined providers (which meet the reporting entity thresholds) that is likely to increase the annual California-derived revenue of the providers by either $10,000,000 of 20% of annual California derived revenue from normal or stabilized levels of operations. Since the MSO is not a health care entity and therefore not required to report, whether the transaction is reportable will depend upon the characteristics of the health care entities that are parties to the transaction.
The definition of health care entity was narrowed in the case of a party that acts as an agent on behalf of other entities, limiting this to parents, subsidiaries, or affiliates of a payer; in the prior versions of the Regulation this applied to entities acting on behalf of providers, delivery systems and pharmacy benefit managers.
The Regulations include an important exception from the definition of reportable material change transactions for transactions that are entered into in the ordinary course of a health care entity’s business. This may serve to exclude ongoing contractual arrangements such as renewals of licenses, upgrades of technology assets or refinancing of an existing debt arrangement, even if the size of the transaction might otherwise meet the criteria for reporting. Conversely, a transaction in which a health care entity enters into a new credit facility with a value exceeding $25 million involving an encumbrance of 25% or more of its assets would be reportable. OHCA has indicated that parties with questions of whether a proposed transaction is reportable should contact its staff for guidance on whether a particular deal will fall within the ordinary course exception, and over time the staff expects to develop and post on its site a Frequently Asked Questions feature.
Other changes in the definition of material change transaction are:
- Exclusion of transactions in which there is only a change in the form of ownership of an entity, for example from public to private ownership or from physician ownership to private equity ownership.
- Modification of the definition as to entities that operate in primary care professional shortage areas, deleting a reference that would have included mental health shortage areas.
- Deletion of the ambiguous word “change” in favor of “transfer” with respect to the assets or governance of a party to a transition, conforming to more customary transactional nomenclature.
- Elimination of a provision concerning transactions in which one party has revenues in excess of $10,000,000, presumably to assure consistency with other size of transaction and size of party definitions.
- Deletion of the provision defining a change of control as occurring upon the transfer of 25% or more of the governance of the management and policies of at least one health care entity in a transaction. OHCA staff determined this was an unmeasurable criterion and was adequately addressed by other criteria.
The Regulations shorten the period of time following complete submission of a notice of material change in which OHCA is required to determine whether or not a CMIR will be required. It must notify parties that a transaction will not be subject to a CMIR within 45 days of filing and within 60 days if a CMIR will be required. The period for issuance of a CMIR following the close of the public comment period to 15 days absent good cause for an extension of time.
Areas of Concern
There are still several areas of concern for parties who may be required to comply with the reporting. The definition of material change transaction still includes an encumbrance of more than 25% of the assets of a health care entity, which means that new conventional lending transactions and bond issuances are reportable if they meet the size of transaction criteria. In a public meeting of the OHCA Board on December 18, the OHCA staff expressed the view that including encumbrances within the definition is necessary because transactions involving significant debt may ultimately result in failure of the entity. It is unclear how studying such transactions, even in a CMIR, will address this concern as the impact of debt on the operations of a party to a transaction may not be seen for some time.
The Regulations also contain ten-year “lookback” rules, which require reporting by a health care entity that has engaged in a series of related transactions involving the same or related health care services involving the same entities or their affiliates or a health care entity that has previously acquired in a similar transaction another health care entity that provides the same or similar services. In these instances, the value of all of the transactions consummated within the preceding ten years will be aggregated to determine whether the transaction meets the asset or revenue tests. According to the OHCA staff, these rules are intended to mirror recently adopted rules of the Federal Trade Commission. If a transaction becomes reportable due to application of the ten-year lookback rules, then a CMIR may consider the cumulative effect of all of the past transactions on costs or the market, rather than focusing just on the immediate transaction.
The final Regulations include a provision for expedited review of material change transactions in which one or more parties are subject to “severe financial distress” or there is a likelihood of a significant reduction in the provision of health care services within one or more geographic regions. The definition of severe financial distress is “grave risk of immediate business failure, such as a substantial likelihood that a party to the transaction (or entity affected by the transaction) will have to file for bankruptcy under Chapter 11 of the federal Bankruptcy Act.” However, the definition does not include a transaction involving a party that is already in bankruptcy proceedings and proposing a sale under Section 363 of the Bankruptcy Code. There is a question of whether such a state regulatory scheme that would attach conditions to an order of a federal court is preempted by federal bankruptcy law. Further, this provision does not relieve a party seeking expedited review from compliance with the filing requirements associated with notice of a material change transaction, which may prove extremely challenging for an entity that is in severe financial distress.
The notice reporting and CMIR regime is intended to complement OHCA’s mandate to establish cost targets for health care entities to promote affordability of health care services by ensuring that potential transactions are reviewed for possible impacts on costs and markets before they are consummated. Questions remain as to whether the new requirements will discourage transactions and the frequency with which OHCA will determine to proceed with CMIRs. In a meeting of the Health Care Affordability Board on December 19, 2023, it was noted that the experience in Massachusetts, which has had a similar regulatory framework in place for ten years, was that 110 transactions have been reported and only 10 have been reviewed. Events during the upcoming year may signal the effects of compliance with the Regulations on transactional activity and how aggressive OHCA will be in responding to transactions affecting the California market.
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