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November 10, 2011

The Law Review: Structuring co-management agreements

Daily Briefing

    The Health Care Law Roundtable is pleased to present the Law Review. Authored exclusively by Law Roundtable members, this biweekly column covers legal topics of interest to the Advisory Board’s hospital membership. This edition, authored by attorneys from Drinker, Biddle & Reath, LLP, explores the role of co-management arrangements in hospital-alignment efforts and key considerations when deploying this strategy.

    Jennifer Breuer, Partner, Drinker Biddle & Reath, LLP.

    John D’Andrea, Partner, Drinker Biddle & Reath LLP.

    Due to health care reform and accountable care, many hospitals are seeking opportunities to align physician interests with hospital programmatic, quality of care and patient satisfaction initiatives. Co-management arrangements are an important addition to the arsenal of hospital-physician alignment tools, but can come with operational and legal pitfalls. 

    In its most robust form, co-management involves the formation of a management company that typically is owned jointly by a hospital and one or more physicians or physician groups who are key members of its medical staff. This management company then contracts with the hospital co-owner to manage a hospital department or service line. The hospital pays the management company a fair market value management fee, which may include fixed and variable incentive components.

    Co-management also can be achieved contractually among the same parties without the formation of a separate company. While company formation allows for the distribution of profits among the company’s investors, as the company generally will not have substantial operations beyond the co-management contract, a similar result can be achieved contractually.

    This Law Review highlights several key considerations for hospitals to keep in mind when structuring co-management arrangements to best assure success.

    Choosing the right physician participants

    As co-management arrangements are intended to advance a hospital’s clinical programs, improve quality and increase patient satisfaction, hospitals should be careful to involve physicians in the management company who are proven physician leaders, and who have demonstrated an interest in advancing these important objectives. Under a co-management agreement, physician participants may personally perform or supervise a variety of strategic, administrative, management, medical direction and similar roles. Hospitals will best be positioned to achieve their objectives if they have engaged physicians in these roles who are enthusiastic and committed, and who are capable of delivering real value.

    Complying with legal requirements

    Co-management arrangements implicate a host of laws, including the Stark Law, the Anti-Kickback Statute, the Civil Monetary Penalties Statute and, for tax-exempt hospitals, federal income tax requirements for continued tax exemption. The parties to a co-management arrangement must pay particular attention to assure compliance with these legal requirements.

    Stark Law


    Stark Law prohibits a physician from making referrals for certain “designated health services” payable by Medicare to an entity with which the physician has a financial relationship, unless an exception applies. Designated health services include inpatient and outpatient hospital services – the very services to be managed under a co-management arrangement – and, as the physicians chosen for co-management arrangements typically are key referral sources for the hospital, co-management arrangements implicate the Stark Law. 


    There are Stark Law exceptions available to protect payments under a co-management contract.  Applicable exceptions generally require that the compensation paid to the management company or physician managers reflects fair market value and is structured in a manner not to vary based on volume or value of referrals. 

    Anti-Kickback Statute

    The Anti-Kickback Statute is broader than the Stark Law and prohibits anyone from offering or receiving remuneration to induce referrals for items or services payable by Medicare or Medicaid. Violation of the Anti-Kickback Statute may result in criminal or civil monetary penalties; as a criminal statute, illegal intent is necessary for a finding of violation. The Anti-Kickback Statute includes safe harbors, compliance with which will exempt a transaction from further scrutiny. Arrangements that do not achieve safe harbor protection will be evaluated based on their facts and circumstances to determine compliance with the Statute.       

    Similar to the Stark law, if all remuneration under a co-management contract is fair market value for services rendered and does not vary in any manner based on volume or value of referrals, the arrangement should not result in violation of the Anti-Kickback Statute. 

    Additionally, it is important to scrutinize the manner in which the management company’s revenues and profits are distributed among participants. Compensation to individual physicians performing services under the co-management agreement should reflect fair market value for the services provided. Further, each investor’s return on investment should be proportionate to his or her investment interest. Additional means to reduce Anti-Kickback Statute risk under co-management arrangements include measures to assure that physicians’ referral patterns to the hospital do not change as a result of the co-management arrangement, and that protections are in place to avoid cherry-picking of patients to achieve the desired quality metrics.

    Civil Monetary Penalties Statute

    The Civil Monetary Penalties (CMP) Statute prohibits payments to physicians as an inducement to reduce or limit items or services to Medicare or Medicaid beneficiaries under the physician’s direct care. As applied to co-management arrangements, it is important to carefully scrutinize variable compensation metrics for compliance with the CMP Statute. 

    Aligning incentives through variable compensation—while maintaining focus on legal requirements

    Variable compensation incentives can be an effective way to appropriately align interests and reward the achievement of program objectives, including in the areas of quality of care, program development, operational efficiencies and patient satisfaction. In structuring compensation models, however, it is important to maintain a focus on the legal requirements.

    Key considerations include:

    • The total compensation available under a co-management arrangement as well as each of the component parts must reflect fair market value. It is imperative to engage a valuation firm to provide an opinion that the compensation model will result in reasonable and fair market value compensation to the management company.
    • Compensation may not vary in any manner based on the value or volume of referrals that may be generated by physician participants for the hospital. While much has been written about the ability to value a co-management arrangement as a percentage of revenue under management, variable compensation to a physician-owned management company should not be based on revenues or profits of the hospital. While a valuator may be able to use such a metric as a comparable for determining the fair market value of an arrangement, in general, neither the Stark Law nor the Anti-Kickback Statute will permit compensation under a co-management arrangement to be structured as a percentage of revenue. 
    • In addition, it is necessary to closely scrutinize incentive compensation metrics to assure they could not be construed as an inducement to reduce care. Specifically, incentives based on cost savings or reduced length of stay could implicate the CMP Statute. Additional means to reduce risk of violation of the CMP Statute include: compensating physicians for specific actions that have been recognized as improving patient care; assuring that no incentive is paid where a specific standard is applied in medically inappropriate circumstances; the quality targets are reasonably related to the practices and patient population of the hospital; appropriate procedures are in place to notify patients of the program and to monitor performance under quality targets; and the performance measures that could result in compensation to the manager or management company are clearly and separately identified. 

    Considering appropriate non-competition covenants

    Hospitals entertaining co-management arrangements should consider requiring appropriate non-competition covenants applicable to the management company and its physician participants.  While it may not be advisable to restrict where physicians may perform clinical services in a co-management arrangement, it is essential to consider whether to impose a non-competition covenant more closely tailored to the management relationship and the services to be performed under a co-management agreement. Appropriate covenants would include a prohibition on ownership of a competing hospital or technical service line and a prohibition on providing similar management, administrative, medical director or other similar services for a competing hospital. 

    For many hospitals, co-management agreements serve as an effective way to integrate with physicians and align physician interests with important hospital missions and objectives.  Careful attention to the above key considerations can help assure a successful co-management program.   


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