Introduction

While behavioral health Mergers and Acquisitions (M&A) activity over the past 12 months is down from 2021- 22 levels, we are still seeing strong investment interest in the space. Key investment drivers include the still-unmet social need for behavioral health treatment, expanded third-party reimbursement and evolving business models that create opportunity for established providers and new entrants alike. At the same time, capital constraints, higher interest rates, inflation, ongoing staffing challenges and lingering economic uncertainty have made buyers more selective and placed an (even) greater emphasis on due diligence and vetting applicable regulatory/third party reimbursement issues. Some sellers have elected to defer a sale process, awaiting improved market conditions and/or stronger financial performance to maximize exit value; parties seeking to transact in current market conditions are well advised to prepare for a thorough diligence process to avoid disruption or delay on the path to closing. For transactions that make it to a letter of intent, market conditions along with heightened regulatory scrutiny place a premium on close alignment between business and legal teams on both sides of the table to support a timely and successful transaction process.

An overview of some of the key legal hot spots we are seeing in behavioral health M&A transactions follows, which we hope will be useful background for market participants.

Let’s Start With Structure

Behavioral health encompasses a wide range of treatment modalities, including but not limited to psychiatric hospitals, residential mental health, substance abuse, eating disorder and IDD treatment facilities; outpatient care modalities ranging from partial hospitalization, intensive outpatient, clinic-based and/or medical practice based; and telehealth/digital treatment. Each of these modalities can hold different licenses issued by different agencies and can co-exist with other modalities in the same treatment program. Implications of this diversity and overlap can drive key organizational and deal structure considerations, some of which are discussed below.

To PC or not to PC

While many levels of behavioral health care fall under a state agency license, certain levels of care may only be rendered by a professional corporation (PC). Often this will be the case for outpatient mental health and/or clinician-provided services within a residential setting in one of the many states that has a corporate practice of medicine prohibition, which can impact legal structure in varying degrees of scope and scale. Where this prohibition exists, and absent an applicable exception, certain clinical services may only be provided through a physician-owned PC.

We are seeing PCs with increased frequency in behavioral M&A transactions, for example, due to the heightened investment interest in outpatient mental health treatment providers where the core service is clinical (including psychiatry, prescribing of medications and certain ancillary services) in nature. On the other hand, residential treatment providers with a more limited clinical service component are at times drawing payor claim and/or credentialing denials due to payors alleging non-compliance with corporate practice of medicine restrictions to deny claims or credentialing. Heightened payor focus on managing and/or minimizing their spending on behavioral health—which has been a reality for behavioral providers for several years—is intersecting with somewhat antiquated corporate practice of medicine rules to create risk of disruption in the key investment thesis areas of reimbursement and revenue cycle. While “friendly PC/MSO” arrangements are common in medical and dental practice-based businesses, the need for such arrangements in behavioral health is sometimes less apparent, and can be more challenging to integrate within, a behavioral health business. The threshold question of when, whether and how to utilize a PC can impact transaction economics (including tax), along with regulatory, revenue cycle and other considerations.

Watch out for Earnouts

While a common means of helping buyers and sellers bridge a valuation gap to reach a mutually agreeable transaction price, earnouts warrant special consideration in healthcare transactions. This is all the more so in light of enhanced governmental scrutiny in the behavioral space, and increased use of earnouts to bridge valuation gaps in light of current market considerations. Transactions where a seller will remain with the target business and will be in a position to generate patient referrals (and simultaneously, improve their personal economics via increasing the earnout value) can raise compliance risks that can in turn depend on the provider type and third-party reimbursement sources, among other factors.

When the target business receives reimbursement from Medicare, Medicaid, or another federal healthcare program, there are compliance and risk considerations under the federal Anti-Kickback Statute (AKS) and analogous state statutes. These statutes prohibit providers in such healthcare programs from offering to exchange or exchanging anything of value to in exchange for patient referrals. A more recent regulation applicable to certain behavioral health providers, and regardless of third-party payor source, is the Eliminating Kickbacks in Recovery Act (EKRA). EKRA prohibits knowing and willful payment in exchange for a patient referral or patronage, related to a recovery home, clinical treatment facility, or laboratory service covered by a health care benefit program (whether government or commercial). EKRA was passed relatively recently to bring federal criminal sanctions to bear on patient brokering and other inappropriate inducements to make referrals or generate business associated with substance abuse treatment, recovery housing and laboratory services. The broad statutory language can make it more challenging to comply with applicable requirements.

Earnouts can be used for sound economic reasons that are not intended to induce or encourage referrals, generation of business or patronage for the business. However, if the parties decide to employ them, care must be taken not to violate either the AKS, EKRA or any applicable state law corollaries. The criteria to be used for earnouts should be carefully vetted by qualified health care transaction counsel to help define and align to targets that are consistent with applicable legal requirements and economic expectations, ideally at an early stage of the transaction.

Things that Change or Stay the Same

The licensure approval process is a key gating and timing item with respect to completion of transactions and can mean the difference between closing later this month, later this quarter, or later this year. This is particularly true for providers that operate via a facility based or agency-issued licenses, as distinct from PCs, where licensure is typically personal to individual clinicians and issued by a medical board or similar body. There is a wide range of state agency formulations for when a licensure change of ownership (“CHOW”) approval requirement has been triggered. Careful assessment and selection of transaction structure can help expedite or avoid pre-closing CHOW approval requirements in some cases. For example, some state agency pre-closing CHOW requirements may or may not apply depending on factors that include: (i) whether the transaction is structured as a stock purchase as opposed to an asset purchase (and whether there will be any change in tax identification number); (ii) the licensing and/or legal structure of the parties to the transaction; and (iii) whether and to what extent an interim management services arrangement between buyer and seller may be available. CHOW process requirements (where implicated) can require filing and approval of a new license application and passing an onsite inspection, along with discretionary review and/ or certificate of need approval, which can add 90 days to 6 months or more to the pre-closing timing. In other cases, post-closing application and/or postclosing notice-only will suffice. 

Heightened service line diversity and complexity of behavioral health providers, along with still-evolving regulatory standards that largely vary by state, make CHOW assessment much less than a one-size-fits all assessment. Engaging in a CHOW assessment at the outset of a transaction process can be a highly valuable component to align with tax and other key structure elements and to serve as a blueprint to timing and execution steps. Similarly, parties will want to assess notice and/or approval requirements with third-party payors, given heightened importance of commercial and government reimbursement for behavioral health providers and to ensure the smoothest possible revenue cycle transition.

“New-ish” for 2024: Additional Approvals and/ or Government Scrutiny Impact and Timing

In addition to the structure and approval gating items discussed above, buyers and sellers alike should take notice of new antitrust and similar review and approval requirements at the federal and state level. These requirements are separate from and additional to the license and third-party payor CHOW approvals noted earlier and will increasingly play a role on timing and likelihood of execution for transactions subject to them. As the large majority of behavioral health M&A transactions have historically been below the Hart-Scott-Rodino Act (HSR) reporting threshold,1 these review and approval requirements merit special attention by behavioral health M&A market participants. We recommend assessment and preparation for applicable filings early in a transaction process, with the help of qualified and experienced health care transaction counsel.

Heightened Federal Antitrust Scrutiny

At the federal level, the DOJ and FTC have withdrawn long-standing health care merger guidance that they viewed as outdated and overly permissive. New merger and consolidation guidelines have now been developed.2 The new guidelines reflect the Biden Administration’s view that “decades of industry consolidation have often led to excessive market consolidation” across multiple sectors, including health care.3 The new guidelines focus on additional theories of competitive harm and lower thresholds at which certain transactions will be presumed illegal under antitrust laws.

For example, the new guidelines presume that a deal is anticompetitive if it results in a post-transaction market share greater than 30% together with an increase of 100 or more in the so-called Herfindahl-Hirschman Index (“HHI”), a measure of market concentration commonly used by antitrust enforcers and the courts. By lowering the threshold percentage of market share and levels of market share concentration several health care transactions, including potentially behavioral health transactions that would likely have been presumed lawful under the former merger guidelines of 2010 may now be presumed unlawful under the new guidelines.

Additionally, there is an acute focus on “rolls-ups” in the new guidelines. When a transaction is a part of a series of acquisitions, the revised guidelines indicate that the agencies will examine the current transaction along with all of the prior acquisitions, even if no single transaction would be considered anticompetitive on its own. This will likely increase the risk of antitrust scrutiny for entities such as private equity firms and health systems that engage in multiple acquisitions of various health care providers. Healthcare industry participants should be mindful of plans to acquire multiple practices and clinics (including behavioral health) and that relatively small transactions that would not by themselves be subject to HSR reporting requirements could be subject to scrutiny, including via lookback to prior similar transactions.

The new guidelines also reflect a focus on impacts on labor markets. Notwithstanding the ongoing staffing shortages that have plagued the behavioral health care and health care sectors for some time, the FTC and DOJ indicated that they are concerned that some transactions may reduce demand for workers and suppress wages and other compensation. The guidelines state that “[w]here a merger between employers may substantially lessen competition for workers, that reduction in labor market competition may lower wages or slow wage growth, worsen benefits or working conditions, or result in other degradations of workplace quality.”4

By contrast, this Newsletter has addressed in past publications the effects and possible solutions to remediate behavioral health staffing shortages, and noted that such shortages are often one of the drivers of behavioral health M&A, joint ventures and other transactions.5

Many market observers are expecting a more hostile regulatory reception to health care M&A transactions, although it remains to be seen how agency application of the new rules and any related legal challenges may play out.

State Level Antitrust-Related Scrutiny and Rise of “Mini-HSR” Legislation

Over the last few years, several states have enacted legislation and promulgated regulations to subject various health care transaction to review that often were not subject to material review before. If subject to the requirements parties to a given transaction may be compelled to make detailed submissions for prior review, and in some cases, approval, before the given deal can be completed. Some commentators observe that these new series of requirements somewhat resemble submissions that must be made for certain health care (and other) deals under HSR, but often for far smaller dollar values than the HSR reporting threshold. Lower dollar reporting thresholds have in part given rise to the label “mini-HSR” legislation, with Washington State and Massachusetts early adopters of health care market review for certain transactions with thresholds driven by provider size and type and revenue source (as opposed to transaction value) capturing deal values far below HSR requirements. More recent examples of recent mini-HSR legislation include (not exhaustive) notice requirements for certain health care entity transactions that may constitute material change transactions meeting certain dollar, property or other prescribed thresholds (and often covering transactions at values well below HSR requirements). There is significant range in these kinds of mini-HSR requirements, including 30-day advance notice for certain defined transactions in New York,6 30-day advance notice for certain defined transactions in Illinois 7 and 90 days advance notice for certain defined health care transactions in California.8

Although these new legal requirements appear more aimed toward the broader health care sector, many of the have potential to directly impact the behavioral health sector as well depending on the state law at issue, how the deal is structured, how the behavioral health care providers are structured and size of the transaction (among other things). Like the licensing CHOW rules noted above, the mini-HSR-requirements can apply or not based on the specific provider and transaction structure attributes of a given transaction. We recommend parties to a transaction assess applicability early. Where applicable, the mini-HSR requirements can add months or even close to a year to the time frame needed to close a deal.

What Should Behavioral Health Providers, Investors and Other Stakeholders Do Now to Help Address These Issues?

As discussed previously, current market conditions warrant special attention to legal structure and regulatory considerations in planning and execution for a successful transaction. Those same considerations, along with a behavioral health M&A market that remains choppy at this time, place a premium on advance preparation for legal workstream items at early stages in a transaction process. Careful attention to structure and approval processes that may be implicated can help keep a transaction moving and avoid surprise and/or delay on the path to closing. Similarly, increased regulatory scrutiny for health care and behavioral health care transactions may create new substantive barriers to investment at a time when behavioral health providers are in need of investment to meet challenges posed by long-term increased demand and more complex business model, operating and reimbursement challenges.

As behavioral health care providers, private equity investors, health systems and other stakeholders consider and plan for investment and transaction activity in the behavioral health space, we recommend the following:

• Get started on legal and regulatory assessment of your deals and the issues discussed above early. The novelty and complexity of these issues and “one size fits few” nature of behavioral health providers means that early assessment may pay dividends in avoiding surprises and helping expedite closing.
• Be mindful that transaction structure can significantly impact necessary transaction approvals and related process, along with substantive regulatory compliance risks. Involve experienced healthcare transaction counsel at early stages in developing the transaction blueprint.
• Plan for and be prepared to conduct thorough legal due diligence, including in the areas of marketing activities/fraud and abuse, reimbursement billing/ coding and privacy matters. Review of these issues with appropriate risk allocation in transaction documents can help protect against potential liability and provide the parties with a greater likelihood of finding appropriate, practical solutions and help facilitate a successful closing.
• Strategize early to try to preemptively address agency antitrust-related enforcement concerns and to try to head off or limit follow up questions/ request and potentially more lengthy review (where applicable). Coordination among buyers and sellers in preparing for such notice and review can help manage and mitigate timing and substantive process considerations.
• Monitor evolving legal and regulatory standards applicable to behavioral health providers, including ongoing changes to federal and state antitrust and mini-HSR requirements as more becomes known on how heightened scrutiny, review processes and/or legal challenges to same take hold.9

1 Effective March 6, 2024, the HSR reporting threshold increases from $111.4 Million to $119.5 Million.

2 https://www.ftc.gov/reports/merger-guidelines-2023

3 https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition-in-the-americaneconomy

4 Supra FN 2. See also, generally “Newly Finalized FTC/DOJ Merger Guidelines Are Likely to Increase Antitrust Scrutiny of M&A Deals” (summarizing anticipated elevated levels and different types of scrutiny that many health care transactions may face under the new guidelines). https://www. polsinelli.com/herbert-f-allen/publications/newly-finalized-ftc-doj-merger-guidelines-are-likely-to-increase-antitrust-scrutiny-of-ma-deals Herb Allen, Arindam Kar, Mitchell Raup, Matthew Hans.

5 See also, “Top Issues in Behavioral Health 2023 and Top Issues in Behavioral Health 2022.” https://polsinelli.gjassets.com/content/uploads/2023/02/ March_23_Behavioral_Health_Newsletter.pdf

6 NY Pub. Health Law §4550 et. seq.

7 IL Public Act 103-0526.

8 CA Health & Safety Code § 127500, et seq.

9 Polsinelli’s Behavioral Health Law Group continues to monitor and assess legal and regulatory trends, along with federal and state antitrust review of health care and behavioral health care transactions.