Focus Areas

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Commercial Reasonableness

Commercial reasonableness is cited in various Stark Law exceptions and federal anti-kickback statute safe harbors regulations, including:

Stark Law exceptions:

  • Office space rental 
  • Fair market value
  • Employment
  • Group practice arrangements
  • Equipment rental
  • Indirect compensation
  • Isolated transactions
  • Personal service arrangements¹

Anti-Kickback Statute safe harbors:

  • Space rental
  • Personal services and management
  • Equipment rental
  • Discounts
  • Acquisition of practice
  • Ambulance replenishing
  • Divestiture  

In 1998, CMS (HCFA at the time), in its Stark proposed rule, interpreted "'commercially reasonable' to mean that an arrangement appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals." ²

Later, in the preamble to the Stark Phase II interim final rule, CMS gave a definition to commercially reasonable as "an arrangement will be considered 'commercially reasonable' in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential designated health services ("DHS") referrals." ³ 

While commercial reasonableness and fair market value are often thought of as the same, they are two distinct and separate issues. Arrangements may meet the definition of being within fair market value however are not considered to be commercially reasonable. For example, a physician provides general surgery medical director services under a professional services agreement with a hospital and is compensated at fair market value; however the hospital is also contracting with two additional physicians to provide identical services; therefore the arrangement is duplicative and may not be commercially reasonable. 

In addition, a transaction may fall outside of fair market value and may fail to meet the definition of commercial reasonableness. For instance, in arrangements at issue in U.S. ex rel. Drakeford v. Tuomey Healthcare System, Inc., the government concluded that transactions at issue in this case were both in excess of fair market value and not commercially reasonable.

An entire transaction should be considered to determine if the transaction is commercially reasonable. In the consideration of commercial reasonableness, it is important to consider multiple elements of an agreement. Can each piece of an agreement stand alone and can all pieces of an agreement stand together? Some important elements of an agreement to consider include, but are not limited to:

  • Term length of the agreement - Is the length of the agreement reasonable? Are there too many fixed components? Are there provisions in place for fair market value renewal?
  • Renewal and termination provisions - Are there provisions in place for termination in the case of significant changes in circumstances or services being provided?
  • Full-time equivalent ("FTE") status - Is the physician's FTE status clearly defined, with compensation and services being rendered reflective of the FTE status?
  • Compensation model (fixed vs. variable) - Is compensation reasonable, and are there provisions in place to account for changes in the physician's work patterns or changes in professional reimbursement?
  • Administrative vs. clinical time worked - Is there a distinction between clinical and administrative services, and is there enough time in a day for the physician to provide all services for which compensation is being rendered?
  • Documented work hours - Is sufficient documentation required for hourly compensation of services?
  • Documented/Supportable need for services being offered - Is there really a need multiple medical directors in the same service line?

Many valuation opinions lack the detail of an arrangement needed to adequately support commercial reasonableness. Expanding the scope of a valuation to address commercial reasonableness often requires inquiry and analysis that go beyond the scope of a FMV-only analysis. Furthermore, some attorneys feel that commercial reasonableness is best addressed by legal counsel; others feel that a team approach to providing input to counsel or the valuation expert are necessary to gain assurances of commercial reasonableness.

Regardless of the stance on the best expert suited to address the issue, care should be taken to ensure that parties responsible for compliance in transactions and compensation arrangements be well versed in the regulatory language on commercial reasonableness, and that commercial reasonableness is treated with the same importance as fair market value when entering into arrangements or transactions between referral sources. 

For more information about commercial reasonableness, contact HORNE Partner Rud Blumentritt, CPA/ABV, CVA, at rud.blumentritt@hornellp.com.

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¹Using slightly different terminology, the personal services arrangement exception requires that services be "reasonable and necessary for the legitimate business purposes."
²63 Fed. Reg. (Jan. 9, 1998), p. 1700.
³69 Fed. Reg. (Mar. 26, 2004), p. 16093.