Let’s Call the Whole Thing Off: Why Health-Care Deals Die

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By Mary Anne Pazanowski

The five to ten percent of all proposed health-care industry transactions that fail before closing do so for a variety of foreseeable reasons, according to attorneys who help put these deals together.

The vast majority of the record number of health-care corporate transactions during the past few years have gone through as planned; very few, relatively speaking, have failed to close. It’s useful, however, to review some of the reasons things may not work out for the parties, the attorneys told Bloomberg BNA, because things can fall apart relatively quickly.

Successful deals today range from hospital mergers and physician practice acquisitions to private equity investments. The trend slowed down a bit following President Donald Trump’s inauguration, but it’s too soon to tell whether this was a minor blip or a longer term shift.

There isn’t any single reason why deals fail, and the parties to every transaction likely will be challenged to work through their difficulties to reach a result that meets the goals of both organizations, Douglas B. Swill, of Drinker Biddle & Reath LLP in Chicago, told Bloomberg BNA.

Transactions Are Complicated

“There are a million things” that go into planning and executing a deal, Randal L. Schultz, chair of the health-care strategic planning group at Lathrop & Gage LLP, Overland Park, Kan., told Bloomberg BNA. As a result, getting to closing can be complicated.

Most failures occur early on, Swill said. Occasionally, however, a deal falls through at the “11th and a half hour.” That’s “highly unusual” and can be very expensive for the parties, but it’s something to keep in mind when advising clients about deals, he said. About 75 percent of Swill’s practice involves transactions.

Paul A. Gomez told Bloomberg BNA attorneys should watch for signs a party’s “enthusiasm for a deal is cooling,” such as “sudden and unexplained changes in responsiveness, revised documents or requests for information.” Gomez, a shareholder with Polsinelli PC in Los Angeles who counsels health-industry clients on deals, said it’s often wise at this point to reach out to the other party to try to determine why there has been a change in attitude and address the party’s concerns.

There are several common reasons why deals fall apart, according to the three attorneys.

‘Time is the Enemy’

“Time is the enemy,” according to Schultz. The longer a deal takes, the more likely it is to break down, he said. Delays give way to doubts, and given time, a party may find a “more attractive partner,” Schultz said.

Parties should set a “prompt but reasonable time frame” and include benchmarks along the way to completing the deal, Gomez recommended as a way to avoid losing deals. This “sends a positive signal to all parties in the transaction that the other party or parties are committed to the transaction and are devoting the necessary thought and resources to complete the deal,” he said.

Swill said “deal fatigue” often presents an obstacle to closing a deal. Deal fatigue sets in when conducting due diligence takes longer than expected, Schultz said. Parties also may get tired of waiting for government approval, if the deal requires it, Swill said. A long delay may lead the parties to think the government has concerns that would unduly hold up the closing or cause it to deny approval.

“Delayed deals also may signal to one or both parties that the other party isn’t as committed to the deal as had been thought initially,” Gomez said. This could trigger “concerns about how interested and committed” the parties will be to the resulting entity after the deal is concluded, he said.

Due Diligence Surprises

Deals sometimes fall apart at the due diligence stage because the parties find unexpected issues. Time, once again, can complicate matters, because the longer a due diligence investigation goes on, the more problems they may find, Schultz and Swill said. The parties may reach a point where they decide it simply isn’t worth it to try to resolve one more concern.

Due diligence is crucial, however, and can’t be rushed, the attorneys said. This is the stage where the parties get to know one another, taking stock of business practices to ensure the transaction will benefit everyone involved. By this point, the parties have signed a letter of intent and agreed not to disclose any confidential information.

Issues can pile on top of one another, leading one party to abandon the deal, Swill said. Parties just get “weary” of trying to resolve issues as they come up, Schultz said. Eventually, they may encounter “the straw that breaks the camel’s back,” and wind up backing out of the deal, he said.

Facts learned during this stage that give rise to concerns that the combined entity probably won’t be as financially viable as the parties had hoped also have torpedoed deals, according to Schultz. Parties may rethink creating a new entity intended to meet certain community needs if those needs have changed due to demographics or reimbursement issues.

Schultz said a deal must result in a competitive advantage for it to succeed. If the parties discover that the “sizzle” that made the deal make sense really isn’t there, it can easily fall apart, he said.

Regulatory and Legal Issues

Regulatory compliance issues also could derail a deal prior to the closing. Parties to a health-care transaction “have to contend with a dense thicket of licensing, certification, accreditation, and certificate of need requirements,” to name just a few, Gomez said.

Compliance with federal and state regulations “can involve significant advance filing and approval requirements that must be met before a deal can close,” he said. Conversions, the combination or ownership change involving nonprofit and for-profit entities, for example, usually require state attorney general approval, Swill said.

“Moving too quickly in the early stages of a transaction without understanding and preparing a plan to address these material compliance and regulatory matters can result in unpleasant and unexpected hurdles and delays to the transaction, Gomez said. He suggested attorneys get involved early on to identify significant regulatory issues, create a plan for how to address them and “set appropriate expectations about requirements and timing to help avoid unwelcome surprises.”

Additionally, an acquiring entity doesn’t want to inherit an anti-kickback statute or Stark law investigation, the attorneys said. The discovery of regulatory noncompliance issues that haven’t yet come to the government’s attention also can cool a party’s enthusiasm for a deal, Swill said.

Existing or potential False Claims Act lawsuits also raise concerns because these actions take years to resolve and may result in multi-million dollar settlements or verdicts. Additionally, multiple private lawsuits alleging medical malpractice or the like could be uncovered during due diligence or filed during the time it takes to complete the deal.

These issues can be worked out in many cases, with the party against whom an action or investigation was brought agreeing to bail out the other should liability be assessed, Swill said. Still, deal attorneys should carefully draft documents clarifying the parties’ representations and warranties regarding regulatory and legal matters, he said.

Incompatible Corporate Cultures

Another issue that can arise fairly late in the game is the discovery that the combining entities just don’t mesh, and Swill and Gomez both put incompatible business cultures on their lists of top reasons deals fail. This reason isn’t unique to health-care entities, but may be especially acute in the health-care space, given “how intertwined it is with professional obligations and clinical standards of care,” Gomez said.

The deals most likely to succeed are those in which the parties’ governing boards and chief executive officers share the same strategic thinking about the best means of delivering quality health care, Schultz said. Key management must agree on the strategies to be developed, Schultz said. Organizations don’t work if their administrators don’t share the same vision or mindset.

Parties must have “at least reasonable faith” the entity across the table “will follow through on the letter and spirit of a given obligation or in a shared decision process,” Gomez said. The agreement they put on paper “can only do so much.”

Other areas of incompatibility also may cause a deal to fall apart. For example, Schultz said, two hospitals proposing a merger may look relatively similar, but could be “totally different” in their approaches to financing and reimbursement. One may be more profitable than the other due mainly to the board or CEO’s management style, he said.

Individual hospitals also have separate agreements with health insurers, so the way their reimbursements are calculated may differ, Schultz said. Additionally, a hospital serving a large Medicare or Medicaid population may rely on government payers, while the proposed deal partner looks to private payers for the bulk of its reimbursements.

Infrastructure/Integration Problems

Due diligence also can uncover physical plant or infrastructure problems that would cost the acquiring entity more than anticipated to fix, Schultz said. Considerable capital expenditures required to replace or repair structures or bring both entities into the same operating position may lead to deal abandonment. For example, an acquiring entity may back away if it would be required to make a big capital outlay to update an emergency department, Schultz said.

Similarly, the entities may find integrating their operations more difficult than originally believed, Swill said. Integration issues arise late in the game, usually after the parties have signed a definitive agreement, but before the final closing. For example, the parties may find their electronic health record systems can’t work together, or the medical staff may revolt when told they have to learn how to operate a new system. Contract issues arise over a termination at this point, but they could be anticipated in the agreement, he said.

Integrating two separate medical staffs, physician practices and other professionals can become complicated, Schultz said. The medical staff needs to be on board as the deal as it goes forward, he said. Hospitals need to attract patients to make money, and a system gets those referrals from its medical staff and the surrounding community doctors. A deal could fall apart if there is something the physicians don’t like about it.

Additionally, the entities need to agree on who will fill key administrative positions. If the resulting entity’s administration comes from both sides, who has the final say? This highlights the need for compatibility.

Unexpected financial issues discovered after the deal process has begun can prevent a successful closing, Swill said. For example, the target entity may be required to repay a substantial government overpayment, or the costs of the deal may outweigh its benefits for one or both parties.

Need for Government Approval

Various government agencies have to sign off on many deals before they can be finalized—yet another complication for entities trying to close a deal.

Schultz, Swill and Gomez all cited the time required to obtain these approvals as a potential deal-buster. A bigger problem, however, occurs when the Federal Trade Commission challenges a deal. Antitrust issues in 2016 stymied highly publicized mergers in Pennsylvania and Chicago, and wins in those areas may give the FTC and the Department of Justice’s Antitrust Division confidence to continue challenging hospital combinations.

Much depends, of course, on whether the Trump administration will be as active in this area as the Obama administration, they said.

There are many and varied reasons to call off a deal, but fortunately most can be anticipated. To protect clients working on transactions, attorneys should ensure deal documents set the time by which the deal should be completed and detail the parties' rights upon termination when the deal can't be salvaged, the attorneys said.

To contact the reporter on this story: Mary Anne Pazanowski in Washington at mpazanowski@bna.com

To contact the editor responsible for this story: Peyton M. Sturges at PSturges@bna.com

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