On October 17, 2019, the Centers for Medicare & Medicaid Services (CMS) formally published its proposed rule (the PSR Rule) to update exceptions to the Physician Self-Referral Law (PSR Law, also known as the Stark Law). For our initial overview of the PSR Rule (and of the Office of Inspector General’s corresponding proposal to update the Anti-Kickback Statute) see here. The PSR Rule contains a number of important proposals to update the PSR Law, including putting forward a definition of the term “commercially reasonable” and revising the definition of “fair market value.”  These terms and concepts are essential to PSR Law compliance, and constitute key elements of a number of exceptions to the PSR Law, including for space and equipment leases, employment arrangements, and isolated financial transactions.

Commercially Reasonable

As noted in the PSR Rule, although the requirement that an arrangement be commercially reasonable can be found in a number of PSR Law exceptions, CMS has only ever provided guidance on the meaning of that phrase in a 1998 proposed rule (and CMS did not finalize a definition of the phrase). CMS now proposes the following definition for commercially reasonable, which it says is in response to requests from stakeholders over the years, and is intended to “reduce the burden of compliance” with the PSR Law:

Commercially reasonable means that the particular arrangement furthers a legitimate business purpose of the parties and is on similar terms and conditions as like arrangements. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.

In presenting its proposed definition, CMS clarifies that it believes “the key question to ask… is simply whether the arrangement makes sense as a means to accomplish the parties’ goals” and notes that this determination is to be “made from the perspective of the particular parties” to an arrangement. The most notable aspect of the proposed definition is that CMS not only concedes that a commercially reasonable arrangement need not always be profitable, but CMS includes that concession in the actual definition (not just in the commentary). According to CMS, this is contrary to a “widespread misconception” among stakeholders regarding commercial reasonableness.

CMS invites comments on its proposed definition of commercial reasonableness above, and the following two alternative proposed definitions that are included in the text of the PSR Rule:

1. “the particular arrangement furthers a legitimate business purpose of the parties and is on similar terms and conditions as like arrangements.” or

2. “the arrangement makes commercial sense and is entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty.”

Fair Market Value and General Market Value

 The requirement that compensation under certain arrangements with physicians be “fair market value” is a fundamental standard under the PSR Law, one that is defined by statute and in CMS’s regulations. In the PSR Rule, CMS notes that the statutory definition actually comprises three elements: (i) a general definition of fair market value (“the value in arms length transactions, consistent with the general market value”); (ii) a qualification for leases generally (that the value cannot take into consideration the intended use); and (iii) a qualification for leases of office space prohibiting adjustments to reflect the proximity between the leasing parties where the lessor refers to the lessee. CMS has expanded the statutory definition of fair market value in its regulations via rulemaking to provide additional guidance, particularly with regard to the definition of “general market value” within that definition, and to provide that rental payments will not be construed to take into account the intended use of leased property if costs incurred for improvements or maintenance are included in the rate.

CMS now proposes to revise its regulatory definition of “fair market value” to “eliminate the connection to the volume or value standard” and instead to provide for a definition of general application, as well as a definition applicable to equipment rentals, and a definition applicable to office space rentals.

CMS, therefore, proposes the following definition:

Fair market value means—

(1) General. The value in an arm’s-length transaction, with like parties and under like circumstances, of like assets or services, consistent with the general market value of the subject transaction.

(2) Rental of equipment. With respect to the rental of equipment, the value in an arm’s-length transaction, with like parties and under like circumstances, of rental property for general commercial purposes (not taking into account its intended use), consistent with the general market value of the subject transaction.

(3) Rental of office space. With respect to the rental of office space, the value in an arm’s-length transaction, with like parties and under like circumstances, of rental property for general commercial purposes (not taking into account its intended use), without adjustment to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee, and consistent with the general market value of the subject transaction.

The proposed definition of “fair market value” is intended to allow parties to arrangements that implicate the PSR Law to more easily determine the definition applicable to the compensation arrangement at issue.

This new definition is accompanied in the PSR Rule by proposed revisions to the definition of “general market value” – the term contained within the generally applicable definition of “fair market value” above. CMS proposes to define “general market value” as:

“the price that assets or services would bring as the result of bona fide bargaining between the buyer and seller in the subject transaction on the date of acquisition of the assets or at the time the parties enter into the service arrangement.”

Additionally, in the case of space or equipment rentals, CMS proposes to define “general market value” as:

“the price that rental property would bring as the result of bona fide bargaining between the lessor and the lessee in the subject transaction at the time the parties enter into the rental arrangement.”

For this term, CMS reverses an approach it previously took to tie the definition to principles of cost reimbursement, and instead proposes a definition it believes will align more closely with valuation principles for “market value” of a transaction.

CMS also explains its view of how the dual standards – fair market value and general market value – interact when assessing an arrangement: fair market value relates to the value in a “hypothetical transaction,” whereas general market value (or market value) relates to the value to “the actual parties to a transaction” occurring within a specified timeframe.  In other words, CMS explains that under the PSR Law the “hypothetical value of a transaction must be consistent with the value of the actual transaction transpiring between the particular buyer and seller” although it need not “always be identical.” This preamble guidance provides an important insight into how CMS may evaluate transactions that implicate the PSR Law if these terms are finalized as proposed.

CMS also invites comments on its proposed changes to the definitions of “fair market value” and “general market value” for purposes of the PSR Law regulations.

Comments regarding the PSR Rule must be submitted to CMS by 5:00 p.m. on December 31, 2019.

This post was co-authored by Michael Lisitano, legal intern at Robinson+Cole. Michael is not yet admitted to practice law.