The California state legislature is currently considering a new bill that, if passed, would require California Attorney General consent and approval for a potentially broad range of mergers, acquisitions, and affiliations in the health care sector.  SB-977 would apply to transactions entered into on or after January 1, 2021, would apply to health care systems, private equity groups and hedge funds seeking to acquire or affiliate with a health care facility or provider and would impose additional criteria for approval on transactions over $500,000.  The bill expands existing regulation of nonprofits and extends regulation to include for-profit entities as well.

In addition to the consent and approval requirements, the bill would establish new substantive antitrust laws prohibiting health care systems from engaging in unilateral conduct that is not prohibited by current antitrust laws, including using market power to raise prices, reduce quality, reduce choice, increase cost, or reduce access to hospital or health care services.  

This bill, as written, could impact M&A, affiliations, other transactions and essential operations of a number of health care providers, including those involving (without limitation) hospitals, license-exempt medical foundation clinics, health care joint ventures, ambulatory surgery centers, behavioral health treatment centers, physician practices and more.  Provisions prohibiting a health care system from engaging in tying or exclusive dealing if it has substantial market power (discussed further below) could effectively prohibit common payer contracting practices, such as clinically integrated networks (CINs) contracting for all member providers and providers competing to be included in narrow-network health plans.   As written, the bill appears to place a great deal of discretion in the hands of the California Attorney General and imposes additional burdens on health care systems, private equity groups and hedge funds to effectuate future transactions.  This may present particular strain at a time that, as the sector begins to emerge from COVID-19, many stakeholders are working to maintain and improve innovative care delivery models and preserve viability of financially distressed health care providers.  Affected parties may need to reconsider timing and material terms of health care transactions in light of this bill potentially taking effect.  

Summary of Key Provisions

The proposed legislation would not apply to acquisitions or affiliations entered into before January 1, 2021, including subsequent renewals.  However, if a material change in the corporate relationship between a health care system/private equity group/hedge fund and a health care facility or provider occurs on or after January 1, 2021, that change would also be subject to the bill. 

Definitions and Scope

For purposes of this bill, a “health care system” is an entity or system of entities that includes or owns two or more general acute care hospitals, adult psychiatric hospitals, or special hospitals within multiple counties, or three or more such hospitals within one county.  “Health care facility” is also broadly defined and would include a wide swath of nonprofit and for-profit facilities, including (but not limited to) hospitals, clinics, ambulatory surgical centers, treatment centers, and laboratory or physician offices located outside the hospital.  “Provider” means an individual or group of individuals that provides health-related physician, surgery or laboratory services to consumers, including, but not limited to, licensees as defined under Division 2 (commencing with Section 500) of the California Business and Professions Code.  An “affiliation” includes an agreement, association, partnership, joint venture, or other arrangement in which a health care system establishes a change in governance or sharing of control, or otherwise acquires direct or indirect control, over the health care facility or provider.  An affiliation would not include a situation in which a health care system only hires or offers employment to a provider.

Transactions Over $500,000

• The bill would require health care systems, private equity groups, and hedge funds to provide notice to and obtain consent/approval from the Attorney General prior to any acquisition or affiliation with a health care facility or provider that is valued over $500,000.  
• The health care system/private equity group/hedge fund bears the burden to demonstrate to the Attorney General that the affiliation or acquisition “will result in a substantial likelihood of clinical integration, a substantial likelihood of increasing the availability and access of services to an underserved population, or both.”  If this is not demonstrated, the Attorney General must deny consent.
• The Attorney General must respond to the notice within 60 days and either: (1) state whether or not the transaction meets the requirements and is cleared to proceed, (2) grant a waiver to the requesting entity, or (3) request additional information from the parties to the acquisition or affiliation. The Attorney General may extend the timeframes by 14 days if public meetings will be held concerning the proposed transaction. 
• Even if the required benefits are shown, the Attorney General may deny approval/consent if it determines that there is a substantial likelihood of anticompetitive effects that outweigh the benefits of a substantial likelihood of clinical integration and/or increase in services to an undeserved population.
• The Attorney General would establish a Health Policy Advisory Board comprised of industry representatives to advise (upon request) whether a given transaction should be approved. 
  Health care systems, private equity groups, or hedge funds located in a rural area may request a waiver to the approval process, which may be granted if either: (a) the affiliation or acquisition would directly benefit the consumers of health care services in rural areas through improved access or availability, or (2) the affiliation or acquisition is needed to improve the health, safety and well-being on consumers in rural areas.

Transactions Under $500,000

• For acquisitions or affiliations with a transactional value of $500,000 or less, health care systems would also need to provide prior written notice to the Attorney General.  
• The Attorney General then has 30 days to advise it does not object to the transaction or to notify of any objection to the transaction based on “substantial competitive concerns”.  If such an objection raised, the burden shifts to the health care system to demonstrate the criteria applicable to transactions over $500,000 and the transaction is then subject to the same standards for consent or denial of consent. 
• If the Attorney General does not respond to the written notice, the transaction may proceed.  
• In its current form, this provision only references health care systems and does not reference private equity groups or hedge funds.
• Even without a transaction, the bill would prohibit any health care system from unilaterally using market power to raise prices, reduce quality, reduce choice, increase cost, or reduce access to hospital or health care services. Such use of market power would also allow the Attorney General to find “a substantial likelihood of anticompetitive effects” for any proposed transaction. 
• A violation is punishable by civil fines calculated by the greater of (a) $1M or (b) “twice the gross gain to the health care system or gross loss to any other party multiplied by two.”
• The bill would prohibit “tying” and “exclusive dealing” by a health care system with market power, and add new presumptions of illegality, including (1) a “health care system shall be presumed to be acting unlawfully if it has substantial market power . . . and the health care system’s conduct involves tying or exclusive dealing,” and (2) “Exclusive dealing is presumed to be anticompetitive.” 

Open Questions

The bill raises a number of open questions regarding its potential application and how it will be enforced.  A few examples of what is currently unclear include (not exhaustive):

• Whether the defined term “health care system” can include “private equity group” and “hedge fund” if such entities have an investment or other qualifying interest in the “health care system”.  
• Whether provisions with references only to “health care system” (and not private equity group or hedge fund) are intentional or inadvertent omissions. 
• For purposes of “affiliation”, what will constitute a health care system establishing a change in governance or sharing of control over the health care facility or provider. 
• Whether approval (or notice) requirements extend to a health care system’s professional services agreement with a medical group or medical groups.  
• Whether such terms and approval requirements pertain to many behavioral health care providers as well given the bill’s definition of “health care facility” which includes, among other things, “treatment center[s]”.
• Whether the approval requirements would apply to health system, private equity, or hedge fund acquisitions of dental practices.
• Whether the bill applies to acquisitions or affiliations at the parent corporation level, grand parent corporation level, or higher up the corporate chain, as opposed to only at the level of the company that directly owns and operates an applicable health care facility or provider.
• What metrics or factors the Attorney General will consider in determining whether a transaction results in a “substantial likelihood” of clinical integration, an increase in the availability of services to an underserved population, or a substantial likelihood of anticompetitive effects that warrant disapproval.
• How the prohibition on “tying” and “exclusive dealing” will be applied to common managed care contracting practices, such as provider networks contracting on behalf of all their members and insurers offering tiered or narrow-network health plans.
• Whether the prohibition on providers’ using market power to raise price will be construed to authorize courts to regulate health care prices.

Likelihood of Passage

The proposed legislation was introduced by California Senator Bill Monning earlier this year.  It passed out of the Senate Health Committee on May 18, 2020 with several amendments, including the addition of private equity groups and hedge funds to the bill.  The bill is currently pending before the Senate Appropriations Committee, which has scheduled a hearing for Tuesday, June 9, 2020

Although SB-977 was originally introduced prior to the current COVID-19 pandemic, supporters are now relying on an anticipated surge in M&A activity after the pandemic as a basis for why the expanded oversight and regulation is needed in California.  The California Attorney General is publicly advocating for passage of the bill.  The Attorney General has previously pursued large settlements against health care systems in the state for alleged anticompetitive conduct.  We understand that organized labor and consumer advocacy groups also support the legislation However, potentially counteracting this to some extent is the arguably enhanced standing in the community that many hospitals and other health care providers enjoy due to their service and care provided during the COVID-19 pandemic.  We further understand that the California Hospital Association (CHA) and possibly others are actively opposing the bill. 

The proposed legislation would be one of the first of its kind in the nation.  Last year, Washington State passed somewhat similar legislation requiring state approval for health care transactions.  Connecticut law also requires prior notice for hospital affiliations and medical practice transactions.  There are other examples as well.  The breadth of those laws have created unintended consequences that result in hospitals and health systems having to receive state approval for even routine and commonplace transactions in some instances.

Conclusion

If passed, SB-977 would have a significant impact on health care providers in California by restricting health care M&A and other transactional activity through a discretionary state approval process and prohibiting a broad range of conduct that is lawful under current antitrust law.  Several stakeholders, including the California Attorney General, are advocating for passage of the bill, with hospital groups and others opposed.  Health care stakeholders who are contemplating potentially impacted transactions in the relatively near future should continue to monitor the bill and consider whether adjustments to certain deal terms and timing of the transaction are warranted.