Hospital-physician practice acquisitions represent a large segment of the very active healthcare mergers and acquisitions market, which will likely continue in 2016.[1]  In New York, an acquiring hospital often forms a new professional corporation owned by one or more hospital-based physicians to acquire the business and operations of a group physician practice in an asset purchase. The acquiring hospital will be able to exercise a level of management and control over the new professional corporation, often referred to as a “captive PC”, through a contractual arrangement with the captive PC.  This captive PC structure is used to comply with New York’s corporate practice laws as well as to allow the group practice to continue operations as a separate entity but with close business ties to the hospital, e.g. with respect to participation in the hospital’s managed care contractual arrangements and access to other resources of the hospital system.  Although the captive PC structure is conducive to allowing the physician practice to continue its day to day operations largely unchanged, the transaction parties need to be aware that any clinical laboratories that were owned by the group practice will need to comply with a much more robust set of regulations following the sale to the captive PC.[2]  These changes will affect clinical laboratories offering, among other services, bacteriology, endocrinology, genetic testing, oncology, toxicology, transplant monitoring, urinalysis, and urine pregnancy testing.

As a general rule, all clinical laboratories operating in New York State must be authorized by the Clinical Laboratory Evaluation Program (“CLEP”) unless they fall within one of the enumerated statutory exceptions of N.Y. Public Health Law § 579.1.  As is relevant here, clinical laboratories operated by a licensed physician who performs lab tests or procedures “solely as an adjunct to the treatment of his or her own patients” are exempt from CLEP certification.  Instead, such physician-owned labs are certified and inspected by the Physician Office Laboratory Evaluation Program (“POLEP”).  This exemption is applicable only to labs that are operated by an individual health care provider or an independently owned and managed partnership or group practice.[3]  Both CLEP and POLEP have advised that when a lab is purchased by a captive PC, that laboratory no longer qualifies for the exemption even though the captive PC would be owned by physicians and the lab would continue to be used as before by physicians in the treatment of their patients.  The agencies have advised that, instead, it would constitute a clinical lab because of the control that the agencies believe the hospital may exert over the lab through its control over the captive PC.[4]  Due to the change in status of the laboratory post-sale, the POLEP certifications held by the labs will not be transferable to the captive PC as part of the transaction.  Accordingly, a hospital[5] that intends utilize a captive PC model to purchase the assets of a physician practice which include one or more laboratories should consider beginning the lab certification process before the transaction is complete to ensure the correct licensure is in place. [6]

Labs that only perform tests classified by federal regulations as waived[7] or provider-performed microscopy procedures[8], and for which POLEP previously issued a Clinical Laboratory Improvement Amendments (CLIA) Certificate of Waiver, will need to obtain a Limited Services Laboratory Registration from CLEP once transferred to the captive PC.[9]  This process is relatively straightforward.  The main requirement is for the hospital to submit an application, which is available online, indicating its current CLIA number.[10]

If, however, a lab will perform moderate and/or high level clinical or forensic testing[11], the lab must obtain a valid clinical laboratory permit from CLEP which is a detailed process that can take a significant amount of time depending on the quality of the lab.  Before applying for a new permit, the director of the lab must obtain a valid certificate of qualification.[12]  To do so, the director must meet certain minimum qualifications in the applicable area of testing and must demonstrate to the department that he or she possesses the “character, competence, training, and ability to administer properly the technical and scientific operation of a clinical laboratory.”[13]  The required director qualifications differ for each category of service that the lab may offer.  For example, an applicant for a certificate of qualification in oral pathology must either be a physician who is currently certified by the American Board of Pathology in anatomic pathology, or a dentist who is currently certified by the American Board of Oral Pathology.[14]  Often, the applicable qualifications will require four years of experience in an acceptable laboratory, including two years of experience with the methods and techniques to be conducted under the director’s supervision.[15]  A laboratory director may be employed at multiple labs, however, the director must disclose all other employment on the permit application, and must accurately report the hours he or she will spend on-site in each lab for every day of the week.

Beyond the requirements for lab directors, an application for a CLEP permit requires a disclosure of ownership statement, a $1,100 registration fee, and creation of a Health Commerce System (HCS) account for access to the Electronic Proficiency Test Reporting System and CLEP’s online permit information management system, eCLEP.[16]  The disclosure of ownership statement requires that all direct and indirect ownership and financial interests in the facility be disclosed, which would require disclosure of an affiliated hospital buyer of the captive PC.[17]

POLEP and CLEP recognize that transitioning from once agency to another can be a lengthy and burdensome process.  Accordingly, under circumstances in which the CLEP permit application process is not completed before a lab is transferred to the captive PC, CLEP has advised that it will generally permit the captive PC lab to continue conducting operations under its prior POLEP certification post-transaction until CLEP certification is obtained, provided the POLEP certification does not expire in the interim.[18]  The captive PC lab must submit written notification on its letterhead to POLEP indicating that a change of ownership has occurred.[19]  However, continued operation under a prior POLEP certification post-transaction, even if temporary, is not without risk to the lab and the captive PC since they are technically operating without the required CLEP license.  Such risk includes the possibility of revocation or suspension of a certification or other disciplinary action.[20]  Additionally, if the POLEP certification expires during the pendency of the lab’s CLEP application, the lab must cease all operations until a valid permit is obtained.  The operation of a clinical laboratory without a valid permit is a misdemeanor, punishable by imprisonment of up to one year, a fine of up to $2,000, or both.[21]

It is imperative that any hospital utilizing a captive PC to acquire a physician practice with a lab begin the CLEP certification process outlined above as early as possible.  Since applications vary based upon the type of services the lab is seeking permission to perform, it is difficult to estimate the timeframe for completion of the CLEP application process.  However, given the risks associated with a lab not having adequate licensure in place, buyers should be incentivized to submit their CLEP applications well in advance of the anticipated closing date of the transaction.