Physician Real Estate Leases with Health Systems: Healthcare Compliance Laws and Rules You Need to Know

Healthcare Compliance Laws and Physician Real Estate LeasesPhysician real estate leases with health systems implicate the federal healthcare laws because those arrangements have the potential to result in financial benefits to both physicians and health systems at the expense of federal healthcare funds.

For example, a physician could receive a financial benefit from a hospital by paying less for medical office space than the “market” would otherwise dictate.

The theory is that in exchange for providing a physician with medical office space at rates below fair market value (“FMV”), a hospital could potentially recoup the money it is losing on that lease arrangement by relying on subsequent revenue from that physician’s downstream patient referrals for services that will ultimately be paid for by Medicare. Payment for patient referrals is strictly prohibited by the federal healthcare statutes and regulations and can serve as a predicate for whistleblower healthcare fraud lawsuits against health systems.

This is not to say that health systems and physicians should never enter into real estate lease arrangements with each other. Regulatory authorities understand that these types of arrangements are inevitable and have, as a result, created rules on how real estate arrangements should be structured and administered. This post will outline some important statutes and regulations governing real estate lease arrangements with referral sources.

Healthcare Compliance Laws and Real Estate Legal Background

Rules Governing Physician Leases with Health Systems

To avoid violating the Stark Law 1, lease arrangements between referring physicians and health systems must comply with the rental of office space exception (the “Lease Exception”) under the Stark Law, which generally consists of the following elements:

  1. Lease must be in writing, signed by all parties, and adequately describe the leased premises;
  2. Term of Lease must not be less than one year;
  3. Leased premises must not exceed that which is reasonable and necessary for the legitimate business purposes of the lease arrangement;
  4. Leased space must be used exclusively by lessee;
  5. Rent must be set in advance and consistent with fair market value;
  6. The rental charges are not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties, using a formula based on a percentage of the revenue attributable to the services performed or business generated in the office space, or per-unit of service rental charges; and
  7. The lease arrangement would be commercially reasonable even if no referrals were made between the lessee and the lessor.2

One of the key elements of the Lease Exception is the requirement for the lease rate to be consistent with fair market value. The Stark Law defines fair market value as the following:

Fair market value means the value in arm’s-length transactions, consistent with the general market value. “General market value” means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition, or the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals. With respect to rentals and leases described in § 411.357(a), (b), and (l) (as to equipment leases only), “fair market value” means the value of rental property for general commercial purposes (not taking into account its intended use). In the case of a lease of space, this value may not be adjusted to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor when the lessor is a potential source of patient referrals to the lessee. For purposes of this definition, a rental payment does not take into account intended use if it takes into account costs incurred by the lessor in developing or upgrading the property or maintaining the property or its improvements.3

CMS does not prescribe a certain method for establishing fair market value and gives health systems discretion to select a method that is appropriate under the circumstances:

To establish the fair market value (and general market value) of a transaction that involves compensation paid for assets or services, we intend to accept any method that is commercially reasonable and provides us with evidence that the compensation is comparable to what is ordinarily paid for an item or service in the location at issue, by parties in arm’s length transactions who are not in a position to refer to one another . . . For example, a commercially reasonable method for establishing fair market value (and general market value) for the rental of office space can include providing us with a list of comparables. We would also find acceptable an appraisal that the parties have received from a qualified independent expert. Although some transactions are not subject to public scrutiny, we believe generally that there should be sufficient documentation of similar public transactions that the parties can use as a basis of comparison. In regions with inadequate direct comparables, such as rural areas, a reasonable alternative may involve comparing institutions or entities located in different, but similar, areas where property is zoned for similar use. For example, a hospital affiliated with a university in one part of the country could be comparable to other hospitals affiliated with universities that are located in similar types of communities.4

Although there is nothing in the applicable regulations that requires fair market analysis to be performed and provided by an independent, third-party expert, CMS has stated the following:

We agree that there is no requirement that parties use an independent valuation consultant for any given arrangement when other appropriate valuation methods are available. However, while internally generated surveys can be appropriate as a method of establishing fair market value in some circumstances, due to their susceptibility to manipulation and absent independent verification, such surveys do not have strong evidentiary value and, therefore, may be subject to more intensive scrutiny than an independent survey.5

Additionally, under the Lease Exception, the lease arrangement must be commercially reasonable. “An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty even if there were no potential DHS [designated health services] referrals.”6

A lease arrangement between a health system and a referral source which is not consistent with FMV and/or which is not commercially reasonable can result in the violation of the Stark Law, which could expose health systems to potential liability to the government.

As it relates to lease arrangements, the Anti-Kickback Statute is similar to the Stark Law outlined above, in that it prohibits space leasing arrangements between health systems and referral sources unless the arrangement meets the space rental safe harbor, which contains similar elements to the Lease Exception.7

Compliance for Healthcare Real Estate Changes Brought by the Final Rule

On October 30, 2015, the Centers for Medicare and Medicaid Services (“CMS”) released the CY 2016 Medicare Physician Fee Schedule final rule (the “Final Rule”), which brought  several significant changes to the Stark Law. The Final Rule, which went into effect January 1, 2016, has brought five important changes and clarifications affecting healthcare real estate.

Indefinite Holdover

The Final Rule eliminated the six-month grace period cap for holdover tenancies, creating indefinite term holdover tenancies provided that the lease arrangements continue under the same terms and satisfy all of the requirements under the Stark Lease Exception, including FMV and commercial reasonableness requirements, supra.

The FMV requirement for indefinite term holdover tenancies brought an important change. Before the Final Rule, holdover rental rates did not need to be consistent with FMV if the holdover rate was set in advance and was consistent with FMV when arrangement was entered into. Now, arrangements under the indefinite term holdovers must continue to comply with FMV. Thus, while the annual rent escalators and holdover premium rates may have met the definition of fair market value and commercial reasonableness at the time the lease was executed, after the lease expires, the fair market value for the rental of the space may have changed to the point where the annual rent escalators are not resulting in the rental rates meeting the definition of fair market value under the Stark Law.

In addition, CMS has reiterated in the Final Rule that parties may charge holdover premiums, provided the premium is set in advance in the initial lease arrangement, or a subsequent renewal, and the rental rate, including the holdover premium, remains consistent with fair market value as that term is defined under the Stark Law. If a lease contains a holdover premium, the parties must apply that holdover premium in the event of a holdover tenancy, and that holdover premium must meet the definition of fair market value.

Timeshare Exception

The Final Rule also created a new exception for timeshare arrangements (the “Timeshare Exception”). The Timeshare Exception consists of the following elements:

  1. The arrangement is set out in writing, signed by the parties, and specifies the premises, equipment, personnel, items, supplies, and services covered by the arrangement;
  2. The arrangement is between a physician and a hospital or a physician organization of which the physician is not an owner, employee, or contractor;
  3. The premises equipment, personnel, items, supplies, and services covered by the arrangement are used predominantly for the provision of evaluation and management (E/M) services to patients and on the same schedule;
  4. The equipment covered by the arrangement is located in the same building where the E/M services are furnished, not used to furnish DHS other than those incidental to the E/M service furnished at the same time of the patient’s E/M visit, and not advanced imaging equipment, radiation therapy equipment, or clinical or pathology laboratory equipment (other than equipment used to perform CLIA-waived laboratory tests);
  5. The arrangement is not conditioned on the licensee’s referral of patients to the licensor;
  6. The compensation over the term of the arrangement is set in advance, consistent with “fair market value,” as that term is defined under the Stark Law, supra;
  7. The arrangement is commercially reasonable;
  8. The arrangement does not violate the Anti-Kickback Statute or any federal or state law or regulation governing billing or claims submission; and
  9. The arrangement does not convey possessory leasehold in the office space that is subject to the arrangement.

The Timeshare Exception can be used to cover not only the use of the space, but also the use of equipment, supplies, items, and services. These additional items, e.g., equipment or supplies, must be covered by other exceptions under the Stark law if one is relying on the Lease Exception. It is important to note that the Timeshare Exception is separate from the Lease Exception, and with the passage of the Final Rule, both of these exceptions under the Stark Law remain intact.  Health systems and physician groups can choose the most appropriate exception under the Stark Law for their timeshare arrangements.

Writing Requirement

The Final Rule clarified that the writing requirement under the Stark Law does not mandate for parties’ arrangements, including leases, to be reduced to a single document. Instead, the written document requirement could be satisfied by a collection of documents, including contemporaneous documents evidencing the course of conduct between the parties. Applying the facts and circumstances test, parties could rely on the following documents to establish a written lease arrangement:

  1. Board meeting minutes;
  2. Documents authorizing payments for the rent and related services;
  3. Hard copy and electronic written communications between the parties;
  4. Fee schedules for rents;
  5. Check requests or invoices identifying rental payments;
  6. Accounts payable or receivable records documenting the date and rate of payment and the reason for payment; and
  7. Checks issued for items, services, or rent.

To successfully satisfy the writing requirement with multiple documents, the documents in the collection must clearly relate to one another and evidence the one and the same agreement between the parties.

Term Requirement

The Final Rule noted that contracts, including leases, do not require express term provisions of one year or more, so long as it could be determined from the parties’ arrangement that it was intended to last a year or more. The one or more year term requirement could be established through contemporaneous writings which showed that the parties’ arrangement in fact lasted for at least one year. In addition, the Final Rule notes that provisions for the early termination of the lease are still permitted. After early termination, however, the parties cannot enter into the same or substantially similar arrangement during that year.

Signature Requirement

The Final Rule adopted a uniformed 90-day safe harbor for temporary non-compliance with the signature requirement, regardless of whether such noncompliance was inadvertent or advertent.  Prior to the Final Rule, there was a distinction between inadvertent and advertent failures to comply with the signature requirements under the Stark Law. Specifically, parties had a 60-day safe harbor to sign leases that were not signed due to parties’ advertent failures and a 90-day safe harbor for inadvertent failures.

Failing to Properly Structure Real Estate Lease Arrangements for Compliance Exposes You to Liability

Real estate lease arrangements between health systems and physicians must be structured in accordance with the aforementioned statutes and regulations. Failure to do so can expose health systems to significant liability under the law. Health systems should rely on knowledgeable and experienced legal counsel and real estate valuation experts and advisors when structuring these types of arrangements to help mitigate their intrinsic regulatory risks. For more information on our healthcare real estate advisory and compliance services, visit our Innovation Center.

  1. See 42 U.S.C. § 1395nn; 42 C.F.R. § 411.350-.389.
  2. See 42 U.S.C. § 1395nn(e)(1) and 42 C.F.R. § 357(a).
  3. 42 C.F.R. § 411.351.
  4. Fed. Reg., Vol. 66, No. 3, p. 944 (January 4, 2001).
  5. Fed. Reg., Vol. 66, No. 3, p. 945 (January 4, 2001).
  6. 69 Fed. Reg. 16054, 16093 (March 26, 2004).
  7. See 42 C.F.R. § 1001.952(b).