Guest Column (March 2006)

 

Deals demand proper due diligence

HEALTHCARE BUYERS CAN AVOID LEGAL PROBLEMS IF THEY DO THEIR HOMEWORK

By Douglas A. Hastings and David E. Matyas

As Wall Street’s enthusiasm for investing in healthcare organizations continues to swell and as recent state and federal laws and investigations have raised the stakes associated with healthcare entities’ operations, it is more important than ever that attorneys working on healthcare transactions be familiar not only with the general due diligence process but also the regulatory issues related to

that particular segment of the healthcare industry.

In simple terms, due diligence is the task of investigating an entity’s operations by:

identifying risks and problem areas associated with the proposed transaction,

identifying issues which must be addressed in the definitive closing documents to the transaction,

furnishing the buyers/investors with a level of comfort regarding the entity’s operations and

assisting in the evaluation of a proper price and structure for the proposed transaction.

Here are some key components of due diligence.

Use a Proven Process

Initial Preparation. Planning and performing a due diligence review requires advanced consideration of the objectives of the investigation to be undertaken. Here are some suggested initial steps a prospective buyer’s attorneys should take in order to become familiar with the transaction and to begin the diligence process:

Review the seller’s “confidential memorandum” or such similar document that describes the nature of the seller’s business

Review (or if necessary draft) the letter of intent

If the seller is publicly traded, obtain documents filed with the Securities & Exchange Commission

Conduct online searches (Lexis-Nexis, Westlaw, Internet, etc.) about the seller and members of its top management

Conduct a general litigation search

Research whether the seller (or any of its personnel) have been excluded from participation in any federal healthcare programs. Search www.dhhs.gov/progorg/oig/new.html and www/exclusions.oig.hhs.gov

Conduct a UCC-1 title search

Determine the Scope of the Due Diligence Review. The type of healthcare organization/provider involved in the transaction and the magnitude of the transaction will determine the scope of the due diligence review. The client should be consulted regarding the due diligence process as the client may have recommendations on the manner with which the due diligence review should be performed, and attorneys should be mindful that clients may have financial constraints that could affect the amount of time spent on due diligence.

It is important to determine the composition of the due diligence team. A transaction involving a healthcare organization/provider can require individuals with an expertise in various subspecialties of the law including, but not limited to:

Health regulatory compliance

Corporate and finance issues

Antitrust

Risk management and litigation

Environmental law

Labor and employee benefits issues

Real estate

Tax

Intellectual property

Coordinate with All Those Conducting Due Diligence. Clients may have different parties conducting different aspects of the due diligence review, and it is necessary to coordinate with these other parties (accounting firms, business consultants, environmental auditors, actuaries, risk managers, etc.). In addition, it is necessary to keep in mind the types of issues these consultants are examining and whether they are conducting this examination on the law firm’s behalf or on behalf of the client.

Due Diligence Document Request Form. A due diligence document request form should identify specific documents, records and files which must be reviewed as part of the comprehensive due diligence investigation. (Please see sidebar for a list of specific real estate-related documents that should be requested.)

In addition, the request form should set forth the general areas which the team must review in order to glean a better idea of the organization’s/provider’s structure and operation. The actual request list can take on several forms, ranging from a brief request for only a few items to an extremely lengthy request list for information regarding all aspects of the seller’s operations.

After reviewing the documents, create an index of the documents reviewed. There may be occasions when the seller has not shared (either intentionally or unintentionally) certain document(s) with the buyer and/or buyer’s counsel, and if the issue of proper disclosure by the seller arises, an index of the documents provided by the buyer may be critical.

Due Diligence of a Healthcare Organization’s Corporate Compliance Program. Although the importance of conducting a due diligence review of a healthcare organization is not a new concept, what is new is that investors are insisting that due diligence teams specifically evaluate the effectiveness of the seller’s corporate compliance program. To this end, always request copies of any internal or external audits conducted pursuant to the compliance plan.

Conducting Employee Interviews. Due diligence is more than just document review. Interacting with a seller’s management team and employees is imperative.

Reporting Findings to the Client. The creation of a formal due diligence report can have several advantages, as it: evidences that the buyer has exercised care prior to entering into the transaction; identifies important issues that can easily then be communicated to management for resolution; and can create a checklist of items that need to be accomplished pre- and post-closing.

Incorporate the Results

The results of a due diligence can impact the price the buyer pays the seller. An obvious example is when the buyer learns that the seller does not have actual title to a majority of the assets that the seller claimed as the property of the seller – obviously, upon learning the true value of the assets held by the seller, the acquisition price would need to be adjusted.

Less obvious, however, could be an example of a buyer learning that the seller had engaged in some questionable activities. Although the buyer intends to terminate these activities, there may be some risk in purchasing the company as an investigation or lawsuit could possibly be initiated in the future. Even though the buyer may be willing to accept this risk, the buyer may only be willing to accept this risk if the purchase price is adjusted or the seller contractually agrees to accept financial responsibility for an investigation or lawsuit.

The due diligence process, therefore, can assist the buyer by helping to even the playing field between the buyer and seller so that the buyer actually knows the value of the seller’s operations.

There are too many other issues associated with due diligence to discuss them all here. But, some of them include: representations and warranties and disclosure schedules, indemnification, conditions to closing, legal representation issues, and successor liability theories.

Take It Seriously

Although due diligences generally are conducted by more “junior level” attorneys, the ramifications of an inadequately performed due diligence can be significant.

If due diligence is not conducted properly, it can result in: the buyer not paying a fair price for the seller’s operations; after the transaction, the buyer unknowingly continuing to participate in improper activities; the buyer inheriting numerous liabilities; and the parties failing to obtain the necessary consents and approvals and/or not making the requisite notifications. Moreover, officers and directors who authorize the purchase of the seller’s assets or stock can be liable to the stockholders for failure to conduct adequate due diligence prior to the acquisition. Attorneys who are conducting due diligence on behalf of a client should be mindful of the consequences that the buyer can face if inadequate due diligence is conducted. q

Douglas A. Hastings and David E. Matyas are members of the Health Care and Life Sciences Practice at the national law firm Epstein Becker & Green PC. For more details regarding the issues raised in this article, please contact either of them at (202) 861-0900.

SIDEBAR – LET’S PUT THIS IN THE USUAL FORMAT OF A SHADED BOX – 2 –COLUMNS WIDE (?) AT THE BOTTOM OF THE PAGE.

Sample due diligence request list

By Douglas A. Hastings and David E. Matyas

When conducting due diligence for healthcare organizations, here are some of the real estate-related documents that should be requested and analyzed:

Deed, lease or other document establishing Company’s interest in particular property

Tax assessments and any notices received from taxing authorities relating to real estate taxes or assessments

Title policy, including all documents, instruments, subdivision and other plats and similar items referred to in the title policy

All documents related to: any grants or conveyances (or agreements to make grants or conveyances) of any interest in the property (including easements, rights of way, leases and licenses); any reversionary interest in the property; material encumbrances on the property; encroachments from or onto the property

Contracts or options to purchase or sell real estate

All documents pertaining to any pending or threatened condemnation, requisition or other proceeding by any governmental authority against the property

All building permits for any construction projects in progress (or about to be commenced) on the property