Ketamine Due Diligence: What Any Buyer Should Know

We have worked on several ketamine acquisitions, and one of the most important aspects of any deal is due diligence. Shortly after term sheets or letters of intent are executed, most buyers send out a due diligence request list to the seller. This post will focus on the healthcare regulatory issues a buyer will want to focus on for a ketamine deal. Because every deal is unique, there is no “one size fits all” advice. However, there are many common elements that we have seen for ketamine deals.

In this article:

Healthcare Regulatory Issues a Buyer Will Want to Focus On For a Ketamine Deal

Because there is a myriad of healthcare regulatory issues for a ketamine clinic acquisition, this post focuses on some of the federal laws that apply. In our next post, we will detail some of the other legal issues a buyer should consider.

Below are some of the common issues we have seen in the various deals we have assisted with. Because each issue is complex, we only provide a summary of the issue below. However, in order not to run afoul of the law, any buyer would be wise to retain healthcare regulatory counsel to ensure that the seller has complied with the law and to ensure that the buyer continues to comply with any laws.

Third-Party Payors and Medicare Issues

Are there contracts with third-party payors (e.g., insurance companies, HMOs, PPOs, etc.)? If so, you will need to review those agreements to make sure you comply with any requirements set forth therein. From a google search, it also appears that Medicare reimburses for certain ketamine-related procedures. Thus, as part of your due diligence, you should request any information related to third-party reimbursement, including whether the seller is a participating provider with Medicare.

If the seller is a Medicare provider, then certain federal laws apply. Those laws impose both criminal and civil liability. The “big three” federal laws that apply when there is government reimbursement are the Anti-Kickback Statute (“AKS”) (42 U.S. Code § 1320a–7b), the False Claims Act (“FCA”) (31 U.S.C. §§ 3729 – 3733), and the Stark law (42 U.S. Code § 1395nn). Moreover, depending upon which state your deal is located, there could be state laws that parrot (and/or can be unique) some of the federal laws. Thus, you will need to review both federal and state laws to ensure the seller has been compliant.

The AKS prohibits paying or receiving anything of value in return for a patient referral. Under the prevailing case law, if even “one purpose” of the payment is to induce a referral, then it is prohibited. The AKS is s criminal statute that can lead to both jail time and financial penalties. Oftentimes, when the federal government brings an indictment under the AKS, it will also bring a count under the FCA. The FCA prohibits people and providers from submitting a “false claim” to the federal government. Thus, if a provider seeks reimbursement that includes any remuneration for a referral, then in all likelihood, they have likewise violated the FCA.

The Stark law is a prohibition on referrals to which a provider has a financial interest (whether directly or indirectly). However, for the Stark law to apply, the services provided must be one of the 10 enumerated “designated health services” set forth under Stark. We have not had the opportunity yet to determine whether any of the ketamine-related procedures falls within one of the designated health services. But, we nonetheless caution a buyer to investigate whether Stark applies to their transaction.

Last, there is at least one Office of Inspector General opinion (which is housed in the US Department of Health and Human Services) that found that the AKS also applies when there is a private third-party payor (e.g., HMOs, PPOs, indemnity insurance, etc.). Thus, even if the seller is not a Medicare participating provider, a buyer would be wise to investigate whether the seller receives third-party payments. If so, the buyer should investigate which federal laws apply.

Compliance Plan

As a corollary to the foregoing, if the seller receives federal reimbursement, then it should also have a compliance plan in place. The Office of Inspector General of the U.S. Department of Health and Human Services has published various guidance on compliance plans (CLICK here for more information about compliance plans for physicians). Compliance has seven elements, including (1) conducting internal monitoring and auditing; (2) implementing compliance and practice standards; (3) designating a compliance officer or contact; (4) conducting appropriate training and education; (5) responding appropriately to detected offenses and develop corrective action; (6) develop open lines of communication with employees; and (7) enforce disciplinary standards through well-publicized guidelines.

We have designed and implemented compliance plans for healthcare clients. Since each provider is unique, care must be taken to tailor a compliance plan to the specific needs of a client. Aside from the foregoing elements, a provider should have policies and procedures that help to effectuate the compliance plan. Moreover, for any compliance plan to be effective, employees must be trained and re-trained on a regular basis. If there is a fraud and abuse issue, and if the provider has a compliance plan that has been properly implemented and followed, then the OIG will consider the compliance plan as a mitigating factor. Thus, having and following a compliance plan is paramount in today’s healthcare environment.

Health Insurance Portability and Accountability of Act of 1996 (“HIPAA”)

HIPAA is a federal law, that among other things, helps to protect the confidentiality of a patient’s medical information (under HIPAA, this is referred to as “protected health information” or “PHI”). In addition to HIPAA, state healthcare confidentiality laws also apply to the extent they are more stringent than HIPAA’s requirements.

As part of any due diligence, a buyer would be wise to explore whether the seller has “business associate agreements” with third parties that assist the provider with healthcare payments, treatment, and/or operations. And, even in the absence of such agreements, a buyer should analyze whether any business associate agreements are necessary for its protection after the deal closes. Also, a buyer should seek information about whether there are any currently known breaches under HIPAA (whether recently reported or still reportable). Not only is there possible civil liability to the federal government, in certain instances, a patient may also have legal recourse against the provider.

Under HIPAA, even receiving due diligence that involves patient information triggers the HIPAA requirements and the business associate requirements. HIPAA was amended in 2013 and now even a business associate has direct liability under HIPAA (CLICK here for more information). If you are selling your ketamine clinics and the buyer requests PHI, you should consider whether a business associate agreement is necessary.

As an aside, any buyer would be wise to procure cyber liability insurance to help protect themselves against HIPAA breaches. Moreover, a buyer should also see if the seller has cyber liability insurance, and if so, whether it will cover any breaches that occurred pre-closing. Fines, penalties and lawsuits can be very expensive if there is a HIPAA breach.

Part 2 Regulations

The Part 2 regulations are often overlooked by healthcare professionals (see 42 USC § 290dd-2 and 42 CFR Part 2). The Part 2 regulations apply when, among other things, a provider provides substance use disorder (“SUD”) treatments and that provider also receives federal funds for such treatments (e.g., Medicare, Medicaid, etc.). Like HIPAA, the Part 2 regulations seek to protect the confidential nature of a patient’s healthcare records when those individuals are receiving SUD treatments. The Part 2 regulations were recently updated (CLICK here for a good summary of the updates). For a good overall summary of the Part 2 regulations, please CLICK here.

Because ketamine can be used for SUD treatment, and because Medicare provides reimbursement for certain procedures, it is important to understand the contours and implications of the Part 2 regulations. Moreover, a buyer may also need to analyze when the Part 2 regulations are more stringent than HIPAA and/or state law, in which case, the Part 2 regulations may apply (instead of HIPAA and/or state law).

State Healthcare Regulatory Issues

Corporate Practice of Medicine Doctrine

One of the issues a buyer will need to consider is the corporate practice of medicine (“CPOM”) doctrine. This is uniquely a state issue, and each state has a different regulatory regime. For some states, like Arizona, the CPOM doctrine is loosely defined by common law. On the other end of the spectrum, states like California have a strict regulatory and statutory scheme for CPOM issues.

At its core, the CPOM doctrine seeks to prevent non-healthcare professionals from making medical decisions or decisions that impact a provider’s practice. For example, if the Buyer is a publicly held corporation, would a provider want the Buyer to direct the provision of care by the provider? Would a provider be ok if the Buyer decided to stop carrying certain products because the margins are not large enough? Aside from the CPOM doctrine, providers have their own ethical and moral obligations that should never be trumped by non-healthcare individuals.

As mentioned above, in Arizona, the CPOM doctrine is defined solely by case law. There are two appellate decisions involving optometrists that serve as the basis for the CPOM doctrine. For example, the first decision was Funk Jewelry Co. v. State ex rel. La Prade, 46 Ariz. 348 (1935). The Arizona Supreme Court framed the issue this way:

The principal question necessary for us to decide is whether the complaint, alleging that the corporation defendant, through a registered optometrist, is employing objective and subjective means and methods, other than the use of drugs, to determine the refractive power of the human eye or any visual or muscular anomalies thereof, and prescribing or adapting lenses or prisms for its correction or relief, states a cause of action for injunction against such practice.

The Supreme Court then found:

Article 11, chapter 58 (sections 2570–2576), Revised Code of 1928, contains legislation defining and regulating the practice of optometry. Therein it is provided that a person desiring to engage in the practice of optometry must be over 21 years of age and of good moral character and possess certain specified educational qualifications, pass an examination before the state board of optometry appointed by the Governor, and obtain from such board a certificate of registration. The qualifications of an optometrist, as thus outlined, of course exclude a corporation from the practice. It cannot qualify and cannot obtain a certificate of registration. It is not of the class of persons the Legislature intended to authorize to practice optometry. It does not possess the necessary moral and intellectual qualities.

Finally, the Supreme Court went on to note:

That a corporation may not engage in the practice of the law, medicine, or dentistry is a settled question in this state. None of those professions which involves a relationship of a personal as well as a professional character, which has to do with personal privacy, can be placed in the same category as druggists, architects, or other vocations where no such relationship exists.

Based upon the foregoing, including the statutory interpretation and authority from other jurisdictions which prohibited the practice of professions in a corporate context, the Arizona Supreme Court held that the defendant’s employment of an optometrist violated the laws regulating the practice of optometry.

At the other end of the spectrum is California, which has an extensive and rigid CPOM doctrine. The California CPOM is derived from the laws for professionals and case law that has developed over many decades. A full discussion of the California CPOM is beyond the scope of this post. However, if you are considering starting or buying a Ketamine clinic in California, we would caution you to seek healthcare regulatory counsel who is fluent in the CPOM doctrine. Deal structures in California are typically more involved than other states because of the CPOM doctrine, and oftentimes require a variety of companies and relationships to effectuate a compliant operation.

State Licensing Issues

Depending upon which state you live in, there could be state licensing issues you will need to explore. In Arizona, we are aware of at least one Ketamine clinic that is licensed as an Outpatient Treatment Center (“OTC”) by the Arizona Department of Health Services. However, we do not know the exact services that are provided by this clinic, which could impact whether a clinic needs to be licensed by the state.

In Arizona, an OTC is defined as “a class of health care institution without inpatient beds that provides physical health services or behavioral health services for the diagnosis and treatment of patients.” A.A.C. § R9-10-101(156). Seems pretty broad? Yes.

In turn, behavioral health services are defined as:

services that pertain to mental health and substance use disorders and that are either: (a) performed by or under the supervision of a professional who is licensed pursuant to title 32 (e.g., physicians and nurses) and whose scope of practice allows for the provision of these services, or (b) performed on behalf of patients by behavioral health staff as prescribed by rule. A.R.S. 36-401 § (A)(11).

So, imagine that Ketamine is used to treat a substance use disorder. Would that then subject the clinic to licensure by the state? There is certainly a compelling argument to be made in that case. And, this is just one example of how a Ketamine clinic could be a regulated entity in Arizona.

What if the clinic you are buying is already licensed by Arizona or another state? What do you need to do to stay in compliance? The first step is to check your state’s regulatory and statutory schemes for licensing. If your state has “change of ownership” or “change in control” requirements, the buyer may very well need to notify the state and update clinic’s application. Alternatively, if you are not buying the stock of the Ketamine clinic, you may need to apply for a license with the new entity that will be running the clinic.

As an aside, and further to Part 1 of this article, if the clinic is licensed as a Medicare provider, you may need to update your Medicare application or you may need a new license altogether if you are not buying the stock of the clinic. Great care must be taken to make sure you are applying under the correct conditions. The Medicare application, which includes sections for amending an application, is the Medicare 855 Form.

Operating Agreements

Arizona passed a new Limited Liability Act (the “New Act”) that became effective on August 31, 2019, but was designed to be implemented in stages. The New Act applies to Arizona LLCs formed, converted or domesticated on or after September 1, 2019, and applied to all other LLCs starting on September 1, 2020. There are various issues under the New Act that should be considered if the selling entity or another entity involved in your deal was organized before the New Act became effective.

Some of the issues under the New Act include:

  1. initiation of derivative claims on behalf of a limited liability company and the treatment of foreign protected series limited liability companies;
  2. voting rights, information rights and dissociation/dissolution rights of limited liability companies, and
  3. fiduciary duties and rights of indemnification of limited liability companies.

These are just a few examples of issues you will need to review and consider. Moreover, you may very well determine that amendments are needed to any such Operating Agreements. Under the New Act, there are many “optional” provisions you could layer into an Operating Agreement.

Before consummating any transaction involving an Arizona LLC, corporate counsel should review such agreements in great detail and advise their clients of the various ways that the agreement can be amended or changed (whether mandatory or permissive under the New Act).

Conclusion

Healthcare is an industry that requires significant substantive knowledge and incredible attention to detail. State law issues, in addition to Federal issues, can be pervasive for a Ketamine deal (and any other healthcare-related deal). Any buyer or seller in this industry should consult with attorneys who are fluent in healthcare laws. Otherwise, the penalties for violating these laws can be quite severe, including criminal penalties and jail time.

Put another way, this is just like medicine – preventative care can save you a lot of time, money, and headaches. Due diligence and retention of the right counsel are tantamount to preventative care for the legal and business worlds.

For more on ketamine, check out the following blog posts: