Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

Kent owns an older nursing home facility located within 4 miles of the proposed new Altercare Stow facility. Kent objected to Schroer’s CON application and requested a hearing, which ODH held over 3 days in June, 2011. During the hearing (and during the appeal), Kent made the following arguments:

1. If ODH allowed Schroer to relocate the beds to the new Altercare Stow facility, the number of beds in the Stark County area would fall below the state bed need rate required by R.C. 3702.593(E)(4). On this point, Kent provided testimony from a legal secretary who worked for Kent’s legal counsel with respect to the distances between the facilities and the method she used to conclude that Schroer’s proposed relocation was not within the 15 mile radius of one of the old facility's location. The witness could not produce any documentation to support her testimony. Schroer provided testimony and documentation from Google maps, Yahoo maps, a GPS visualizer, and the Medicare website that the required number of beds remained within the 15-mile radius required under the statute.
2. The Schroer/Altercare Stow project is not financially feasible. On this point, Kent attempted to have an expert CPA provide testimony that Schroer's accountant did not comply with the required American Institute of Certified Public Account (AICPA) standards in preparing the financial feasibility study for the Altercare Stow facility. Kent’s expert acknowledged, however, that Schroer’s study provided the appropriate disclaimers required by the AICPA standards. Furthermore, Kent's expert could not specifically opine that the Altercare Stow facility was not financially feasible. Schroer provided several witnesses, each of whom testified to the Altercare Stow project's financial feasibility.
3. The Altercare Stow project would adversely impact other providers of similar services in the service area, including Kent. On this point, Kent’s executive director testified that the opening of the new facility would cause a drop in Kent’s census, but the executive director also admitted that this drop could be attributed to other reasons, including the Kent facility's age, its low number of private rooms, its lack of an activity room, its low shower-to-resident ratio (only one shower for every twenty-five residents), and the fact that Kent had received citations in 2010 for failure to properly care for pressure wounds and failure to properly administer medications through feeding tubes.   

On November 2, 2011, the ODH hearing examiner issued a report recommending that the CON application be denied on the sole basis that the relocation of beds from 1 of the 3 existing facilities would cause the number of beds in that facility’s service area to fall below the state bed need rate for that facility’s location. Aside from that, the hearing examiner found that the CON application withstood all other objections.

Both parties appealed the hearing examiner's decision. By adjudication and order dated December 9, 2011, ODH’s Director modified the examiner's findings of fact and rejected the examiner’s conclusion of insufficient beds to meet the state bed need. The Director accepted the examiner's remaining conclusions and thus approved the CON application.

Kent appealed to the Ohio Court of Appeals for the 10^th District, but the Court affirmed the Director's decision to grant Schroer’s CON application. In reviewing the Director’s decision, the Appeals Court will affirm if it finds “that the order is supported by reliable, probative, and substantial evidence and is in accordance with law.”

THOUGHTS ON THE CASE:

1.         Timing of CON Application. Note that Schroer filed its CON application in July 2007, but ODH did not deem it complete until February 2011, and that the appeal was just decided in September 2012. This delay could have been the result of any number of factors.   If a lender encounters a deal where the CON has not yet been granted, it is important to inquire further into the status of the application process and keep in mind that the CON approval process could take several years.

2.         Application to Financing Transactions for Construction of Nursing Homes. If a lender encounters a construction loan transaction where a CON is (or may be) required, extra due diligence is needed. There are risks to construction lending involving CONs that are unique and require a dialog. The earlier the lender have this conversation, the better. Some items for discussion and consideration include: 

(a)        Has the borrower applied for the CON? If not, when will it apply?

(b)        There is a moratorium in Ohio preventing the creation of new nursing home beds, therefore, existing nursing home beds must be relocated from another facility. This must be done in accordance with Ohio's bed need rate law (O.R.C. 3702.593). The timing and level of scrutiny for the move depends on the source beds' location. Therefore, if the CON is pending, it is important to ask about the beds' source. 

(c)        If a CON has been granted, have all appeal periods of the CON grant expired? Have the potential borrower provide a copy of its letter from the ODH approving the CON. This letter will also be valuable to as it will contain other information about the approved project, including the approved cost of the project.

(d)       If a bridge loan or finance an earlier phase of a project while a CON is pending for a later phase is contemplated, think about the following:

(i)         Does the current phase of the project support the loan if the next CON is denied and construction is never completed on the future phase?

(ii)        For a bridge loan, is there a viable exit strategy if the CON is never granted and there is no take-out construction loan financing?

Know Its Reputation

Health care entities, especially those that engage in medical specialties, rely heavily upon referrals from consumers and professionals. A bad or marginal reputation will not be transformed magically into a good reputation because a health care entity has a new owner. Indentify and check referral sources to understand the reputation of the entity being sold. Often in smaller or closely held businesses, the owner is the source of the reputation.  When the business is sold and the former owner is gone, referral sources may diminish, resulting in deteriorating occupancy rates. 

Understand the Assumption of Risk

A seller that receives reimbursement from Medicare has been assigned a Medicare number. When the business is sold, the Medicare number attaches to the new owner, unless the new owner applies for and receives a new number from the Centers for Medicare and Medicaid Services (CMS). Application for a new number can add time and contingencies to transactions. When the buyer assumes the seller's provider number, the buyer assumes the record of compliance violations and the sanctions and fines that accompany the number, and CMS will pursue the new owner (i.e., the holder of the provider number) for a remedy. CMS will not chase the seller. Indemnification provision in lending agreements provide little solace in the face of a CMS enforcement onslaught. If compliance problems are identified in the due diligence process, discussions with regulators may be required to understand the severity of the problem and the impact the problem may have upon the business. Negotiations with the regulators may not be out of the question. 

Determine Its Billing and Revenue Projection Accuracy

Projected revenues are sometimes overstated because accountants who prepare statements relied upon by lenders may not take into account the collectability of accounts receivable. Revenue projections and the collectability of claims submitted to payers are influenced by a number of factors. First, the amount billed may not be the amount third party payers have contracted to pay. Second, projected revenues may not adequately take into account collection and bad debt histories. Third, claims may be submitted with a high degree of inaccuracy, resulting in denials or substantial delays in payment, effecting in turn estimates of per-day revenues – an especially important factor in the valuation of nursing homes and long term care centers. Due diligence is required to determine what discounts the health care entity has agreed to and how that might effect projected revenues; whether projected collections have been overstated and bad debt has been understated, and if the claims submitted have a history of being incorrect. 

Identify Building and Licensing Issues

In many states, change of ownership of certain health care entities requires re-licensure. The licensing process may bring to light the fact that the facility is in noncompliance with code but has received waivers from the state that release the seller from the requirement to repair and upgrade or that grant a delay.  Waivers sometimes are not transferrable upon sale, resulting in nasty surprises for the new owner or lender when confronted with unanticipated but mandated costs during the re-licensing process. A review of the existing license along with waivers and exceptions related to building code requirements will minimize this risk.