A proposed Calif. bill that would require the attorney general to sign off on any healthcare provider transaction exceeding $1 million would likely stifle mergers and acquisitions, regulatory experts said.

The legislation would give California Attorney General Xavier Becerra—who would have 60 days to review a deal involving providers, private-equity firms and/or hedge funds—an “unprecedented expansion of authority,” experts said, noting that the $1 million threshold would encompass most healthcare transactions.

While providers argue that hospitals and physician groups will close if they have to clear the bill’s “over-reaching” standards, others claim that if implemented well, the bill could provide necessary oversight that could help maintain competition and keep prices in check. But the legislation as it is currently worded, leaves a lot open to interpretation, experts cautioned.

Under current California law, the standard of review is an easier bar to clear, said Paul Pitts, partner at the law firm Reed Smith. The attorney general typically only reviews transactions where not-for-profit entities sell “a material amount of assets,” like when they are sold to for-profit companies. Regulators check whether the deal improperly benefits any private entity, raises antitrust concerns, is at fair market value and aligns with the not-for-profit’s community-oriented charitable mission.

Under SB 977, providers will have to prove that the change of control will either result in a substantial likelihood of clinical integration or a substantial likelihood of increasing or maintaining the availability and access of services to an underserved population. But those standards are unclear, Pitts said.

“These standards are highly subjective and insert a great deal of uncertainty into a transaction,” he said. “Healthcare systems and private equity will be very reluctant to spend significant time and money negotiating and preparing a deal with this much uncertainty around their ability to close the transaction.”

Ironically, clinical integration is an area where larger systems are excelling, Pitts added, asking if this bill may stifle further clinical integration by leaving the California healthcare system more fragmented and less efficient than it might otherwise be.

SB 977, authored by Sen. Bill Monning (D-Calif), would also authorize the attorney general to penalize providers $1 million or twice the gross gain to the health system or gross loss to competitors resulting from overarching market power. In the event of a formal lawsuit, the bill would impose monetary relief for the state of three times the total damage sustained, including legal fees and interest.

In addition, the bill would create a health policy advisory board that includes representatives from health systems, physician groups, insurers, employers and unions, among others. It would go into effect Jan. 1.

“I am not seeing that this as an issue so widespread in the state that it requires this solution,” said Jill Gordon, a partner at the law firm NixonPeabody, noting that the bill may have been influenced by the state’s antitrust case against Sutter Health, which is set to finalize a settlement next month. “In our work representing providers in these transactions, going through the AG review process increases the cost of a transaction by at least $100,000, depending on the complexity of the deal. That is a huge expense for providers.”

The bill, which is in the Calif. Assembly Appropriations Committee, is opposed by the California Hospital Association, among other provider groups. It would subject a broad array of healthcare transactions to an “extreme, burdensome, and exclusionary process of approval” that would limit access and provide a chilling effect “on necessary partnerships during unprecedented times.” It would also create presumptions that M&A is anti-competitive without offering meaningful due process, the groups wrote in a letter to the committee.

“This approach will force smaller providers out of business, especially at a time when California must focus on preserving the current condition of the health care delivery system in order to meet pent-up post-COVID-19 demand, while still maintaining readiness through the current state of emergency with relentless COVID-19 cases and ahead of the 2020 school year and flu season,” the letter reads.

It may also affect longstanding agreements that come up for renewal or arbitration, they noted.

The bill could have a material impact on access to the needed capital for struggling systems and put California at a disadvantage, the law firm Foley & Lartner wrote in a client note, adding that the legislation does not discriminate between control transactions, working capital matters or other financing arrangements. It will chill potential private equity or hedge fund backing of transactions, the firm noted.

While there is consolidation across some of California’s vast 58 counties, many markets are still fragmented, Gordon said. Much of the power is in the hands of the payers, she said, questioning why there is so much focus on providers.

“There’s not a lot of fat for providers in California to take out of the system, particularly with all the managed care and capitated payments,” Gordon said. “A lot of smaller entities are going to shut their doors because they won’t be able to do a deal to affiliate to stay relevant and afloat as a result of this statute.”

There is strong Democratic support for the bill, including Becerra, the California Labor Federation, Health Access California and Western Center on Law and Poverty.

They argue that healthcare consolidation increases prices and stifles competition, citing several studies that illustrate the negative consequences of health system expansion.

In 41 highly concentrated California counties, the percentage of hospital-employed physicians increased from about 25% in 2010 to more than 40% in 2016, according to a 2018 Health Affairs study. Researchers estimated that the shift in ownership translated to a 12% increase in Affordable Care Act premiums, a 9% hike in specialist prices and 5% boost in primary care prices from 2013 to 2016.

The concept of the bill, which would provide a structural mechanism to focus on much of the California healthcare system that is already excessively concentrated, is sound, said Glenn Melnick, a healthcare economist at the University of Southern California. While it would be good to keep tabs on the significant amount of consolidation that otherwise flies under the radar, the implementation will be key, he said.

“The $1 million threshold worries me,” Melnick said, noting that the Federal Trade Commission’s is higher. “If they come up with very clear guidelines that don’t inhibit a smooth functioning market but at the same time protects competition, I like that. If on the other hand, they take the time to review every single $1 million transaction, that is not good.”

If a retiring doctor is trying to sell his practice and this bill artificially depresses the price of that transaction, that would be a problem, he said. The other problem is there isn’t a lot of research—outside of large health system transactions—on how much concentration is too much, under what type of provider and under what conditions. Consolidation can lead to efficiencies and economies of scale, but if it goes too far, there isn’t adequate price competition, Melnick said.

“We need good research to develop nuanced policy,” he said.

Washington state has a similar bill that requires attorney general notification with deals between a Washington entity and out-of-state entity, where the out-of-state entity generates $10 million or more in services for Washington residents.

The Massachusetts Health Policy Commission requires all providers to notify regulators when ownership changes occur between organizations that received at least $25 million in net patient service revenue the prior year, as well as risk-bearing provider organizations.

“(In SB 977) where they are trying to get at the idea of clinical integration and the amount of discretion the AG has to determine what that is is unprecedented,” he said. “There is no law in any other state with this kind of review.”

There are antitrust and licensing reviews in California, like any other state, but there is no reason for regulators to deny the deal if the forms are completed and they have gone through the process, Pitts said.

“This is a whole different scenario,” he said.

The Appropriations Committee voted on the bill on Thursday. If approved, the changes would need to be approved by the state Senate by the end of the month. The governor would have to sign the bill by the end of September.