Healthcare is a highly regulated industry, particularly where transactions between physicians and hospitals are concerned. As a physician, whether you’re employed by a hospital, independent, or independent and considering becoming employed, you should be familiar with the legal constraints that govern hospital-physician transactions.

The main regulations that impact hospital-physician relationships include:

  1. Anti-Kickback Statute: This statute makes it a criminal offense to willingly and knowingly offer, pay, solicit or receive any remuneration, induce or reward referrals for services or items that are reimbursable by a federal healthcare program.
  2. Stark Law: The federal physician self-referral law that prohibits a physician from referring Medicare patients for designated health services (DHS) to entities with which the physician or an immediate family member has a financial relationship (unless an exception applies). Included in the DHS, among other things, are lab; physical, occupational, speech therapy; radiology and other imaging services; radiation therapy services; home health, and IP and OP hospital services. A financial relationship includes compensation, interest and investment, as well as ownership.
  3. Tax-Exempt/Non Profit Hospitals have additional regulatory restrictions that include following Internal Revenue Service (IRS) criteria necessary for maintaining tax-exempt status under section 501(c)(3) of the Internal Revenue Code.

In enforcing these statutes, the Office of the Inspector General (OIG) looks at several aspects of the hospital-physician relationship:

Referrals: The term “Referral” is broadly defined. A referral can be direct or indirect, meaning that physicians would be considered to have made referrals if they caused, directed or controlled referrals made by others.

Fair Market Value: According to Stark Law, “fair market value” means the value in arms-length transactions is 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, on the date of acquisition of the asset or at the time of the service agreement.

Commercial Reasonableness: In short, 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 referrals.

In our experience, fair market value and commercial reasonableness are two areas that are the most difficult for physicians to fully understand. Also, commercial reasonableness is a separate analysis beyond that of a fair market value analysis.

It is imperative to note that commercial reasonableness and fair market value are “not” synonymous. It is possible that a proposed transaction or compensation arrangement can be within the fair market value range, yet may not be commercially reasonable.

Given the statutory environment outlined above, it is important that the hospital work diligently in determining the fair market value of the practice they are acquiring or the compensation model they are proposing. Typically, the hospital will engage an outside firm specializing in healthcare valuation and compensation to determine the fair market value.

Approaches to Value: The three approaches to value are:

  • Income Approach is based on the principle that value is directly related to the present value of the future benefits (cash flow) that inure to ownership
  • Market Approach is based on the principle that an investor will not pay more than market price for an asset
  • Cost (Asset) Approach is based on a practice’s underlying assets and liabilities

In most physician practice acquisitions, the Cost or Asset Approach will be utilized in determining the fair market value price for the practice.

Compensation: The proposed compensation plan will be analyzed to ensure that it falls within the range of fair market value and is commercially reasonable.

Intangible Assets (Areas of Conflict): Assigning values to the intangible assets utilizing the Cost Approach, when under the Income Approach they are not supported by net cash flow, is a much debated and conflicted area of valuation. Intangible assets would include patient lists (records), workforce, goodwill, etc. Goodwill, however, is difficult to quantify and something most hospitals are unwilling to pay for.

Argument for inclusion under the Cost Approach:

  • Costs associated with recreating patient records
  • Costs to recruit and train the workforce

Argument against inclusion under the Cost Approach:

  • The assets do not generate income
  • OIG guidance through the Thornton Letter

In these cases, sometimes it comes down to the level of risk that a particular hospital is willing to take.

Complying with these aspects of the law means four things to physicians:

  1. Hospitals are limited by law on what they can offer to pay physicians for medical directorships, co-management agreements, Professional Services Agreements and similar arrangements.
  2. Hospitals are also limited by law on what they can pay physicians they employ, including the amount they pay to acquire a practice and the physicians’ compensation going forward.
  3. Acquiring a physician practice takes time. Hospitals must conduct due diligence and complete both the credentialing and valuation process before they can make an offer. It’s not unrealistic for the acquisition process to take up to six months to complete.
  4. Physicians should not think they are held harmless by the regulatory bodies and cannot plead ignorance of Stark Law and Anti-Kickback violations.


Kari Craig

Senior Manager