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CMS Makes Things Nonexclusive: Immediate Changes to the Stark Law Will Impact Health Care Leases

This Bulletin is brought to you by the Real Estate Affinity Group of AHLA’s Hospitals and Health Systems Practice Group.
  • December 18, 2020
  • Andrew Dick , Hall Render Killian Heath & Lyman PC
  • Kiel Zillmer , Hall Render Killian Heath & Lyman PC
  • Joel D. Swider , Hall Render Killian Heath & Lyman PC
  • Joseph Wolfe , Hall Render Killian Heath & Lyman PC
  • Gerard Faulkner , Hall Render Killian Heath & Lyman PC

On November 20, 2020, the Centers for Medicare & Medicaid Services (CMS) issued its Final Rule modifying various Stark Law provisions, including those specifically geared toward real estate arrangements. For a general overview of the Final Rule, please see AHLA’s hub dedicated to the Final Rule, including several podcasts, webinar links, and bulletins.

This bulletin provides a summary of those parts of the Final Rule and CMS commentary related to office space and timeshare leasing arrangements. The Final Rule largely confirmed the anticipated changes set forth in the Proposed Rule issued on October 9, 2019. It is important to note that the final regulations take effect on January 19, 2021. Health care organizations will need to move quickly to react and adapt to the interpretations and positions taken by CMS in the Final Rule.

Changes to Definitions and New Definitions

The Final Rule provided key guidance on the “Big 3” Stark Law requirements of (1) fair market value; (2) commercial reasonableness; and (3) the volume or value of referrals. In doing so, CMS offered helpful commentary for health care entities structuring real estate arrangements.

Fair Market Value (FMV)

CMS restructured the definition of FMV to provide for a definition of general application, a specific definition applicable to the rental of equipment, and a specific definition applicable to the rental of office space. CMS also finalized changes to the definition of “general market value” specific to each of the types of transactions contemplated in the Stark exceptions—asset acquisitions, compensation for services, and the rental of equipment or office space. CMS noted that this approach will provide parties with ready access to the definition of fair market value with the attendant modifiers that are applicable to leasing arrangements.

More importantly, the Final Rule provided valuable insight into how CMS interprets FMV in the real estate context, including the following:

  1. CMS reiterated the history of the fair market value standard, including the initial statutory construct (which specifically mentions leases) and CMS’ prior positions on the definition pertaining to leases during the various iterations of Stark.
  2. CMS elected not to finalize the references to “like parties…under like circumstances,” which appeared in the Proposed Rule, with respect to setting FMV rental rates under the rental of office space exception. CMS ensured that the final definition as it pertains to leases did not significantly differ from the statutory definition.
  3. CMS finalized the following two-part definition related to the rental of office space:
    • Fair market value means with respect to the rental of office space, the value in an arms-length transaction 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.
    • General market value means with respect to the rental of equipment or the rental of office space, the price that rental property would bring at the time the parties enter into the rental arrangement as the result of bona fide bargaining between a well-informed lessor and lessee that are not otherwise in a position to generate business for each other.
  4. Regarding the definitions above, CMS removed previous regulatory text stating that for purposes of the definition of “fair market value,” a rental payment does not take into account intended use if it takes into account costs incurred by the lessor in developing or upgrading the property or maintaining the property or its improvements. CMS reiterated that rental payments may reflect the value of any similar commercial property with improvements or amenities of a similar value, regardless of why the property was improved. CMS noted that this is still its policy and explained that it only removed this language because the prior text caused confusion among stakeholders.
  5. Several commenters requested guidance on how to establish fair market value. For example, one commenter asked for validation on the “cost-plus” guidance from Phase I for determining and documenting fair market value as appropriate for timeshare arrangements. CMS reiterated its position from prior rulemakings that it will not prescribe any particular method for determining fair market value and that it will accept a range of methods for determining fair market value. CMS noted that the appropriate method will depend on the nature of the transaction, its location, and other factors. CMS alluded to discussions in prior rulemakings where it provided extensive commentary on potentially acceptable valuation methods (e.g., providing a list of comparables, independent appraisals, documentation of public transactions, and “cost-plus” reasonable rate of return methodologies). CMS made clear that it has never said that parties have to obtain an independent appraisal to document fair market value.

Commercial Reasonableness

CMS finalized the following definition of “commercially reasonable”:

Commercially reasonable means that the particular arrangement furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.

CMS retained the idea set forth in the Proposed Rule that compensation arrangements subject to the Stark Law may be commercially reasonable regardless of profitability. CMS explained that the key question when determining if an arrangement is commercially reasonable is whether or not it makes sense as a means to accomplish the parties’ legitimate business goals. However, the fact that an arrangement ultimately achieved a legitimate business purpose of the parties does not necessarily mean that it was commercially reasonable. Each inquiry will be fact-specific and depend on the characteristics of the parties, including their size, type, scope and specialty. CMS indicated that it views the updated standard as more objective since it requires an assessment of the characteristics of the parties themselves rather than focusing only on the perspectives of those parties, which was how prior CMS commentary had framed the commercial reasonableness discussion.

CMS also clarified that the additional requirement that leased space “does not exceed that which is reasonable and necessary for the legitimate business purposes of the lease arrangement” in the office space exception is separate from the commercial reasonableness standard. According to CMS, this language is intended to prevent sham lease arrangements where the rental charges are for office space for which the lessee has no genuine or reasonable use.

The Volume or Value Standard

CMS finalized an objective test that defines exactly when leases will be considered to “take into account” the volume or value of a physician’s referrals or other business generated. Under the new test, leases will only be considered to take into account the volume or value of referrals (or to take into account the volume or value of other business generated) if the mathematical formula used to calculate the amount of rent includes referrals or other business generated as a variable and if the amount of the rent correlates with the number or value of the physician’s referrals to or the physician’s generation of other business for the entity. CMS noted its belief that there is great value in having an objective test, and that the Final Rule establishes such a test. CMS gave an example of an arrangement where a physician leases space from a hospital for $5,000 per month and then is provided a $5 rent reduction for each diagnostic test that the physician orders. CMS said that the mathematical formula $5,000 – ($5 x each referral) would include referrals as a variable and would fail the objective test.

Changes to Exclusive Use Requirements

CMS finalized a change to the exclusive use requirement in the office space exception that now allows a lessee (and any other lessees operating in the same office space) to use the office space at the same time so long as the lessor (or any person or entity related to the lessor) is excluded from the space. This change provides greater flexibility and certainty to lessees who may now utilize space together at the same time with other entities, provided that the arrangement satisfies the other requirements of the office space exception. This represents a win for providers because it will allow lessees to more efficiently collaborate within leased space.

Expanding Which Exceptions May Apply to Space Leases

CMS finalized its proposal that space lease arrangements, which otherwise may not be protected under Stark’s office space exception or the timeshare exception, may nevertheless be protected under the fair market value exception. This significant departure from CMS’ positions in previous rulemaking provides health care entities with greater flexibility for one-off arrangements that are shorter than one year or arrangements that otherwise do not qualify under the office space or timeshare exceptions. CMS provided examples of potential arrangements that could be protected under the fair market value exception, including lab draw stations and short-term or transitional arrangements with a term of less than one year.

In the Final Rule, CMS further confirmed its position that other exceptions, even beyond the office space exception and fair market value exception, may protect space lease arrangements. For example, although it neglected to finalize any changes to the arrangements with hospitals exception (which protects remuneration provided by a hospital to a physician if the remuneration is unrelated to designated health services), CMS reiterated that the exception could cover, for example, rental payments made by a teaching hospital to a physician to rent his or her house as a residence for a visiting faculty member. Likewise, CMS repeated that the payments by physician exception could protect payments by a physician for the lease or use of space other than office space, such as for leases of hospital-owned storage space or residential real estate. CMS also finalized its proposal for a new exception for arrangements with limited remuneration under $5,000 per calendar year (adjusted annually for inflation), which also may be available to protect one-off or short-term lease arrangements with terms that are set in advance but are not captured in writing.

Monitoring and Resolving Errors

Finally, regarding ongoing implementation of lease arrangements, CMS discussed administrative errors, such as invoicing for the wrong amount of rental charges (that is, an amount other than the amount specified in the written lease arrangement) or entering a typographical error in an accounting system. CMS stated that parties that detect and correct administrative or operational errors or payment discrepancies during the course of the arrangement are not necessarily “turning back the clock” to address past noncompliance. Instead, CMS clarified that it is a normal business practice, and a key element to an effective compliance program, to actively monitor ongoing financial relationships, and to correct any problems that this monitoring uncovers. An entity that detects a problem in an ongoing financial relationship and corrects the problem while the financial relationship is still ongoing is addressing a current problem and is not “turning back the clock” to fix past noncompliance. CMS did point out that the failure to remedy such operational inconsistencies could result in a distinct basis for noncompliance. CMS also finalized a special rule that permits parties to resolve payment discrepancies within 90 days following the end of an arrangement. These clarifications by CMS will decrease technical violations due to glitch administration errors like failing to implement a consumer price escalator as long as the errors/discrepancies are resolved.

Practical Takeaways

The Final Rule shows that CMS has delivered on its promise to work on modernizing and streamlining the Stark Law as it pertains to health care real estate arrangements. It is important to note again that most of the changes in the Final Rule go into effect soon on January 19, 2021.

If you would like additional information about the Final Rule as it pertains to health care real estate arrangements, please contact: