According to New York’s Department of Health Commissioner, “nearly half [of] New York’s 227 hospitals are financially distressed.”[1]

What then is the future for New York’s hospitals, especially in light of healthcare reform and declining reimbursement rates?

Historically in New York, hospitals and the delivery of patient care have been viewed as “charitable” endeavors. In an effort to ensure that there are no conflicts of interests that adversely affect patient care, New York law generally prohibits investor-owned corporations from owning and operating health care facilities.

Realizing that for-profit investments could help stimulate and restructure distressed hospitals, Governor Cuomo’s proposed 2014-2015 budget and associated legislation attempted to authorize a two-year private equity pilot program (the “Pilot Program”) whereby up to five for-profit corporations, subject to approval by the Public Health and Health Planning Council (and subject to a number of other regulatory requirements), would be permitted to invest in various health care facilities.

Earlier this month, the final budget adopted by the New York State legislature did not include Governor Cuomo’s proposed Pilot Program.  Many in the health care industry view the rejection of the Pilot Program as a rather unfortunate outcome, as the for-profit turnaround players with deep pockets and the requisite operational expertise might have been welcomed by the many financially distressed hospitals in New York.  Now, those health care facilities in dire need of financial and operational assistance could continue to struggle, potentially inhibiting the accessibility of quality care to many patients and creating  economic stresses on  surrounding communities.

Could, however, such criticism be misguided, and the rejection of the Pilot Program perhaps be a blessing in disguise?

Governor Cuomo is correct in the notion that for-profit investment capital could help to resuscitate distressed hospitals and health care facilities.  However, we would note several concerns that suggest that New York could investigate other approaches, rather than try (for a third time next year) to implement a limited pilot program.

First, could the Pilot Program, if resurrected and finally passed by the New York legislature, be attacked in the courts for its exclusion of publicly traded entities and private corporations with more than thirty-five owners?  What is the constitutional basis for differentiating between the investment and operating expertise brought by a closely held private equity fund versus a public company hospital operator?  If the concern is that a publicly held or larger privately owned hospital company is driven by financial concerns, it would be hard to sustain that argument when the operator is now owned by a private equity fund. And what would the selection criteria be to differentiate between various private equity buyers? It could be suggested that, rather than trying to achieve public policy objectives indirectly by imposing limitations on the type of investor, New York State could directly regulate to achieve its public policy objectives – for example, by requiring community participation on the hospital board of directors, by imposing a minimum charity care requirement on for-profit owned hospitals, by regulating payments to hospitals (much like the State of Maryland already is doing) or by requiring approvals to material service line changes (such as through the already existing Certificate of Need (CON) process).  If those concerns are directly regulated, then is there a need to confine these changes to a limited pilot program or could the market be opened up to all industry participants who agree to play by the new rules selected by the State?

Second, what restrictions and scrutiny will be placed on hospitals participating in such Pilot Program?  If those hospitals are distressed (which is the likely scenario), those hospitals may need to restructure service lines, legacy liabilities, union contracts, and/or pension expenses – will regulatory flexibility be provided, or will the for-profit operators face the same or even higher regulatory hurdles? If we take as a given that much, if not all, of the initial Pilot Program hospitals will be distressed, then it will be important to define at the outset what is “success” under the Pilot Program, as the process of restructuring distressed hospitals is rarely easy or pretty and can lead to assertions that the Pilot Program has failed (even while, in fact, the hospitals have survived and begun to turn around).  For example, it is not uncommon to see work-outs and bankruptcy sales of distressed hospitals, which often lead to a stable restructured hospital – but would that be seen as a success for the Pilot Program?

Finally, attention should be paid also to the objectives of the hospital investors.  There is a need for certainty with respect to dividend distributions and exit transactions, otherwise the value to investors of participating in this pilot exercise is severely restricted.  Would the exit possibilities for a private equity investor be limited to a sale back to a non-profit entity or another private equity fund, or could there be other exits available – such as an initial public offering of its stock or a sale to a larger private company or a publicly traded entity?

It will be interesting to watch the events of the next few months unfold as more distressed hospitals either reach out to the State of New York for further financial support or as they are acquired by New York’s larger nonprofit hospital systems. We expect to see continued consolidation in the New York market in the next year, as the community, the healthcare industry and investors watch with interest.

We welcome comments and questions, so please leave a comment below and let us know.