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Non-Profit Management, A Look at Legal Structures for Nonprofit Organizations Seeking Affiliation Partner

April 6th, 2020

This article was previously published in the Central New York Business Journal on March 20, 2020, and the Rochester Business Journal on March 27, 2020.

“America’s healthcare system is neither healthy, caring, nor a system.”

— Walter Cronkite

Walter Cronkite died in 2009. I am not sure of the date of this quote. However, the “most trusted man in America” was certainly accurate when he said it. Progress towards the development of an integrated healthcare delivery system has been elusive for decades.

More recently, the COIVD-19 epidemic/pandemic spread rapidly throughout the globe. The 24/7 daily news media have been glued to this terrible and unfortunate illness for more than a month now. It certainly is and will continue to be a major story and will significantly affect health and human service providers throughout the country.

There is no good time for an epidemic/pandemic. However, for New York State tax-exempt health, human, and social service providers, COVID-19 could not have come at a worse time. The New York State Medicaid program, with expenditures exceeding $70 billion each year, is under extraordinary downward budgetary pressure as the Governor and Legislators finalize the State budget for the fiscal year beginning April 1, 2020. Increasing Medicaid expenditures have been accelerating since the adoption of the Affordable Care Act (ACA) in 2010. The ACA raised the poverty threshold for Medicaid eligibility to 133% of the previous threshold, resulting in an additional one million New Yorkers being eligible for Medicaid benefits. One out of every three New Yorkers is now eligible for Medicaid benefits.

NYS budget issues this year and in prior years, coupled with the recent Federal rejection of the Department of Health application for an $8 billion extension of the Delivery System Reform Incentive Program (DSRIP), have resulted in many providers evaluating and questioning their future autonomy.

The fact pattern described above, together with many other variables, has accelerated the number of mergers, affiliations, and acquisitions between and amongst tax-exempt health, human, and social service providers.

A number of years ago, I developed and wrote a column on the affiliation continuum referred to as “from autonomy to acquisition.” The 10 steps in the continuum were/are as follows:

  1. Autonomy.
  2. Co-Optation.
  3. Collaboration.
  4. Shared-service agreement.
  5. Contractual affiliation.
  6. Regional network formation.
  7. Joint venture.
  8. Partnership/corporation.
  9. Merger.
  10. Acquisition.

The last five items in the continuum involve structure, governance, and formation of one or more legal entities. Given the recent acceleration in mergers, affiliations, and acquisitions, this column is devoted to providing additional guidance to Board and Management Team members with respect to the most common legal structures that may be applicable if your organization is looking for an affiliation partner. This guidance provides the most common approaches to structural affiliations. Obviously, in evaluating the alternatives described below, knowledgeable and expert legal counsel must be retained. The following are typically extremely complicated transactions that require expert professional advice.

  • Parent/Subsidiary Model – Affiliation with Another Provider under a Common Parent Entity – This is the most common affiliation structure used over the past 15 years as the hospital industry has gone through its own consolidation/affiliation process. This model typically allows for the local entity Governing Board to remain intact, with the possible addition of Board members from the parent entity’s Board. Generally speaking, this model provides the parent entity with “Sole Member” control of the subsidiary entity, with the inclusion of certain reserve powers for the parent. These reserve powers include, but are not limited to, the ability to appoint as well as terminate Board members of the subsidiary entity. In addition, this model generally includes the adoption of a new Management Organization Chart that includes new or reassigned Management individuals for administrative, program, and functional support purposes.
  • Full Merger– This model is frequently used when one entity is much larger than the affiliating entity, and there are program synergies that support the adoption of a single merged entity. Unasserted claims, litigation, and other related issues can frequently disqualify a full merger from consideration. In this model, the program service operating certificates would be transferred to the surviving entity. The Board of the affiliating entity would be dissolved, and that entity would most likely be liquidated over a two- to five-year period in order to address the unknown liability issue. Certain Board members of the affiliating entity, but not a controlling number, would be appointed to the merged entity Board. This merged entity structure results in full control by a single Governing Board and a single Management Team. This model is frequently deemed to be the most cost-efficient affiliation model but must consider the impact of rate and regulatory requirements.
  • Sole Member Structure Without Formation of a New Parent Entity – Many affiliating organizations do not intend to complete multiple affiliations and, therefore, do not see the need for a newly established parent entity. In this model, the existing controlling entity establishes sole member status with specific reserve powers. Typically, the reserve powers in this particular model may provide for greater autonomy to the Board and Management of the affiliating entity. The affiliating entity Governing Board remains intact, with the possible addition of one or more Board members from the controlling entity. This model, while not common, is typically utilized when both organizations are financially and operationally strong. The affiliation is driven by opportunities for administrative cost efficiencies as well as program service and geographic expansion.
  • Regional Network Formation – Individual Practice Association / Independent Provider Association – The government mantra for health and human service providers continues to be predicated on the development of “Integrated Delivery Systems.” For more than 40 years, physicians have created Regional Provider Networks for purposes of contracting with Managed Care Organizations on the basis that the Individual Practice Association structure would facilitate both clinical and financial integration of physicians. With the enactment of the ACA, these physician IPAs (Individual Practice Associations) have joined health systems in forming what is now known as Accountable Care Organizations, focused on risk-based population health contracting. In addition, both Medicare and Medicaid reforms of the last 10 years have initiated the implementation of individual health and human service provider organizations forming IPAs, now commonly referred to as Independent Provider Associations. As a result, the IPA designation now refers to either physician networks or provider service entity affiliations. In many cases, the formation of an IPA network may lead to an evaluation of whether or not certain organizations believe that one of the affiliation models referred to above would result in additional cost efficiencies and program service expansion. In each of the four models described above, there is an inherent objective of fulfilling the charitable purpose of the organizations and being responsive to community needs.
  • Management Services Agreement (MSA) – The MSA model can be used as a transitional structure to accomplish any one of the four alternatives described above. MSAs are frequently utilized as the first step in affiliation/merger transactions. Using marriage as a metaphor, an MSA allows providers to date each other and possibly get engaged before taking their final marriage vows (for example, structural merger or affiliation models discussed above).

An integral component of the upcoming State budget will be driven by the recommendations of the Governor’s recently appointed Medicaid Redesign Team (MRT). MRT recommendations are likely to result in many health and human service providers needing to evaluate their future viability as autonomous organizations.

In my view, substantially all health and human service providers need to evaluate the strategic objective of expansion through mergers/affiliations/acquisitions as an opportunity to cost-effectively enhance the organizational mission and respond to community demand. If every organization were willing and able to follow this path, there will be substantial progress towards the elusive objective of an integrated health and human service delivery system for our community. For those of you who remember Walter Cronkite and his famous sign-off to network news, “And that’s the way it is.”

The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.

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Charlie Wood April 2020
Charlie Wood
Practice Lead, FoxPointe Solutions
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The Bonadio Group