Regulatory Oversight 3: Guide to Communities Considering Hospital Conversion in the Carolinas

Notification of the State Attorney General
North Carolina's Municipal Hospital Act does not specifically require that public hospitals notify the Attorney General of a proposed conversion agreement. However, in the absence of these laws, some hospitals may elect voluntarily to alert the Attorney General or other state regulators of a pending arrangement in order to establish a positive working relationship.4 Again, in determining a time frame for notification, it may be wise to opt for earlier, rather than later, as this prevents a nearly completed transaction from being stopped or substantially slowed due to potential conflicts, saving a considerable amount of time and money for the parties involved.9

* Although not required to do so, Wake Medical Center voluntarily provided the Office of the North Carolina Attorney General with a copy of its proposed agreement. No formal written opinion was given regarding the proposed agreement.

Regulating the Use of Hospital Conversion Proceeds
In stark contrast to the multiple legal mechanisms for the protection of the charitable assets of not-for-profit hospitals through the establishment of a foundation, the statutes regulating the conversion of public hospitals do not offer specific direction for the use of the conversion proceeds. In this sense, county officials are in charge of protecting the interest of the public through the soundness of their decisions regarding the appropriate use of these assets in their communities.

* For Piedmont Hospital, this lack of regulation resulted in the sale of a county facility to a for-profit hospital with the construction of a new hospital, yet no creation of a foundation to manage the sale proceeds, as would have occurred had a not-for-profit hospital been sold. The county subsequently spent most of the proceeds on non-health investments, including purchase of a fire truck, a county office complex and welcome center. Some of these expenditures are ones unlikely to have been undertaken by a non-profit foundation. Nevertheless, they presumably were made with the intent of benefiting the community. Judgments regarding the appropriateness of these decisions are entirely subjective and some may believe that the electoral process provides adequate accountability to ensure that such funds are not misspent.

Although the North Carolina Municipal Hospital Act contains no direct mechanism to protect hospital conversion proceeds, other provisions help ensure the future of health care in the community. These include the following:

Maintaining Community Benefit
The Act clearly addresses the continued provision of community benefits by stipulating certain levels of care that must be reached or maintained if a county facility is sold or leased to a for-profit hospital. The law also includes provisions to guarantee levels of service, indigent care and acceptance of beneficiaries of public health insurance programs (i.e. Medicaid and Medicare). Less stringent requirements also apply in the case of a sale to a not-for-profit hospital entity.

Compliance Monitoring Mechanisms The Act also specifies a clear mechanism for post-conversion compliance monitoring after a for-profit sale or lease. The statute requires that the for-profit hospital submit an annual report showing compliance with the requirements of the transaction. However, there is no statutory provision regarding how this reporting requirement should be audited. Failure to comply with the terms of the agreement may result in the purchaser losing ownership of the hospital.

Table 13 outlines some related elements in the North Carolina Municipal Hospital Act.

CONVERSION AND ANTITRUST
Considered largely irrelevant to the health care industry prior to the mid-1970's, antitrust concepts now are routinely applied to health care providers. Antitrust law is thus a factor as hospitals adopt various strategies of consolidation and integration. Antitrust statutes seek to protect consumers by preventing monopolization by one single hospital or health care system over a geographic market, product or service line. Simultaneously, to encourage efficiency and free market competition, agencies with antitrust review authority have sought to promote arrangements having pro-competitive effects. Antitrust review of a hospital conversion may occur at either the federal or state level.

Federal Antitrust Review
One or more divisions of a state Attorney General's Office, as well as several key federal agencies may review potential hospital conversions for antitrust issues. The federal laws used by these agencies to judge the antitrust implications of proposed agreements include three statutes: the Sherman Act, the Clayton Act, and the Federal Trade Commission Act. These statutes are interpreted by the enforcement agencies and the courts in the context of the factual circumstances of a specific transaction. The Sherman Act is the oldest and most fundamental of these.34 Section 1 prohibits unreasonable restraints of trade brought about by various agreements, while Section 2 prohibits monopolization or unfair practices creating a monopoly. The Antitrust Division of the Department of Justice (DOJ) is responsible for enforcing the Sherman Act, under which it is authorized to bring criminal or civil actions in federal district courts and recover damages suffered by the United States government.

The DOJ also has jurisdiction to enforce the Clayton Act, which, in Section 7, prohibits mergers and acquisitions that threaten competition. Other relevant portions of the Act are Section 2 (also known as the Robinson-Patman Act), which prohibits price discrimination, and Section 3, which addresses illegal exclusive dealing and tying arrangements. The DOJ may obtain civil injunctions under authority of the Clayton Act, as well as recover damages for the federal government. The last of the federal antitrust laws is the Federal Trade Commission Act, enforced by the Federal Trade Commission (FTC), which prohibits unfair methods of competition and unfair practices. In addition to enforcing this latter Act, the FTC is partially responsible for Clayton Act enforcement.

What Guidelines Exist to Assist Hospitals With Antitrust Compliance? In response to the steady increase in the number of mergers and acquisitions in health care markets over the past several years,, the DOJ and FTC ("the Agencies") have experienced a similar rise in the number of transactions reviewed. Although statutory law provides a core structure for hospitals to analyze the potential antitrust implications of an agreement, much of the practical guidance for hospital integration is derived from statements published periodically by the Agencies. In 1992 for the first time the Agencies issued guidelines jointly. These are updated periodically, with the most recent revisions issued in March 1997.

When considering an agreement with potential antitrust implications, these guidelines permit a converting hospital to have a clear understanding of the current standards in use for determining antitrust violations. However, it is also necessary to understand that these guidelines are "useful tools" for reviewing proposed situations, and are not necessarily binding in a court of law. This, again, reinforces the need for a hospital to retain the use of experienced legal counsel to guide the conversion process.

As discussed later, states may preempt federal enforcement of antitrust regulations by establishing their own standards to analyze the antitrust implications of hospital consolidation.

How Do Antitrust Agencies Determine if an Agreement is Anti-competitive? Generally speaking, the statutes used by federal antitrust regulators to review proposed hospital transactions require that agreements between entities not substantially lessen competition or create a monopoly in their relevant areas. Therefore, antitrust scrutiny focuses primarily upon two issues: 1) the presence of restraints on competition and 2) the potential for an agreement to result in a substantial increase in market power in an industry. The DOJ, the FTC and the courts typically analyze the presence and legality of these situations in the specific transaction under review through the use of two standards: per se and the rule of reason.

Restraints of Trade. Restraints of trade–such as price-fixing arrangements intended to eliminate price competition within an industry–constitute a violation of the Section 1 of the Sherman Act. If the courts to review a transaction apply the per se standard, the behaviors typically considered to be in restraint of trade (described below) are treated as inherently anticompetitive and automatically in violation of the law. If the agreement is judged as per se violation, no further adverse effects on competition need be demonstrated for the agreement in question to be illegal.34 In the absence of certain compelling evidence to the contrary (see rule of reason analysis), the following practices are assumed to be per se restraints of trade: 1) bid-rigging and price-fixing among competitors; 2) market division practices; 3) tying arrangements requiring exclusive dealing with a certain entity; and 4) group boycotts of a competitor, a buyer or a seller.47

Antitrust regulators may also determine the presence of restraints of trade by using a second standard, the so-called "rule of reason," to judge the relative necessity of the agreement to further a legitimate goal. Rule of reason analysis first ascertains the presence and extent of the "demonstrable adverse impact"34 of the challenged arrangement on competition. If such an agreement is found to affect competition, the courts will weigh the pro-competitive benefits of the arrangement against its anticompetitive impact to determine if it is in violation of federal antitrust laws. An agreement may be judged permissible if the enterprise is found to have significant pro-competitive effects and adequate evidence of the necessity of the behavior to achieve the arrangement's purpose. Although it is evident that the rule of reason standard requires a more time-consuming and costly review by the courts, it has been cited as the prevailing standard for analysis of agreements dealing with potential restraint of trade.47

Clearly, the use of a particular standard of analysis by the courts may well determine the fate of the agreement under review. In preparing for antitrust review and approval, hospitals must carefully assess the components of the proposed agreement and estimate the likelihood that either standard will be chosen. As most agreements will contain elements that are simultaneously procompetitive and anticompetitive, individuals must base this judgment upon the transaction's more dominant tendency.47

Increase in Market Power. A merger or acquisition may violate the Clayton Act or the Sherman Act if the new agreement results in a significant concentration in the relevant geographic market that substantially lessens competition (although this may not be the case in the integration of hospitals in larger areas with substantial managed care penetration). Therefore, antitrust review to analyze the acquisition of market power is accomplished by regulators using a step-by-step process to describe the proposed arrangement, as follows:

Define the product offered in the marketplace (this may include a service, product or a combination of both services and products).
Define the geographic boundaries of the market affected by the proposed agreement. This analysis may focus upon the ability of consumers in an area to obtain the product in question from other suppliers.
Identify the competitors in the market, based upon the definition of both the product and the geographic market.
Determine the effect of the new combination of competitors on market power, usually focusing on whether the enterprise can impose a significant, non-transitory price increase without losing so many customers that the increase is not profitable overall.