INSIGHT: Dealmaker’s Corner—Substance Use Disorder Facility Acquisitions

Oct. 1, 2018, 1:30 PM

Investment in and consolidation of substance use disorder treatment centers and sober living homes has been a hot area of healthcare transactions for some time, and is expected continue at a robust pace for the foreseeable future. Although transactions in this space are similar in some respects to other healthcare transactions, providers, investors and other stakeholders should take care in legal and financial due diligence to address the areas in which substance use disorder treatment centers are unique.

This article focuses on several issues and risk areas that are specific to substance use disorder treatment facility acquisitions. This article begins with a brief recap of what has driven the recent consolidation of and investment in substance use disorder treatment programs and facilities and why this trend is likely to continue. Legal compliance and regulatory issues that are often confronted in substance use disorder facility acquisitions and to an extent, sober living facilities, are also addressed along with common deal considerations and potential pitfalls. The article concludes with key take away points and what substance use disorder providers can expect on the road ahead.

Key Factors That Are Driving Substance Use Disorder Facility Acquisitions

Severity of the Problem and Access to Payment for Treatment

Every day, more than 130 people in the United States die as a result of opioid addiction and abuse. The Centers for Disease Control and Prevention estimates that the total “economic burden” of prescription opioid misuse alone in the United States is $78.5 billion a year, including the costs of healthcare, lost productivity, addiction treatment, and criminal justice involvement. Over one third of this amount is due to increased health care and substance use disorder treatment costs ($28.9 billion), and approximately one quarter of the cost is borne by the public sector in health care, substance use disorder treatment, and criminal justice costs. Although recent data shows that the rate of new users of heroin and overall number of Americans abusing opioids has declined, usage rates of other substances such as methamphetamine have increased. And it was reported recently that more Americans die annually from overdoes and suicide than diabetes. In short, the substance use disorder problem remains severe.

Availability of Payment for Treatment

Partially in recognition of these concerning trends, the Affordable Care Act (ACA) was signed into law in 2010, which, among other things, established the prevention, early intervention, and treatment of mental health and substance use disorder disorders as an “essential health benefit” that must be covered by health plans offered on the Health Insurance Marketplace. In tandem with the Mental Health Parity and Addition Equity Act of 2008 (MHPAEA), new or expanded behavioral health benefits became available to an estimated 60 million Americans. More recently, legislation like the Comprehensive Addiction and Recovery Act of 2016 has been enacted to address the prescription drug and heroin use crisis, and state and federal dollars have otherwise been earmarked for programs targeting the prevention and treatment of mental health and substance use disorder. In 2017 alone, the U.S. Department of Health and Human Services (DHHS) issued over $800 million in grants to support access to opioid-related treatment, prevention, and recovery, while making it easier for states to receive waivers to cover treatment through their Medicaid programs. These funds were recently followed by several additional grants and awards of federal support, including DHHS awarding over $1 billion in opioid-specific grants. And there are currently efforts underway to eliminate certain restrictions on use of Medicaid funding for care in substance use disorder treatment centers. The compromise opioid legislative bill was passed by the House with overwhelming bipartisan support on Friday, Sept. 28, 2018. The Senate is expected to vote on the bill early this month and the President is expected to sign it into law.

As availability of payment for the prevention and treatment of substance use disorders and other mental health illnesses increases as a result of the developments noted above and others, demand for treatment is likely to increase. Moreover, independent substance use disorder providers are likely to be acquired with greater frequency by larger, more sophisticated and better capitalized entities that are attracted by treatment providers with broader and more stable revenue streams.

Technological Advancement and Changing Perceptions

Advances in technology that help increase access to substance use disorder treatment and monitoring on a remote basis, whether by phone, computer, watch or app continue to promote both availability and demand for care. This is important, because although societal attitudes about substance use disorder and other behavioral health needs appear to be shifting and the associated stigma lessening, these barriers to accessing treatment remain. Technology that facilitates remote care (as appropriate) can help to provide a route past such barriers. Better healthcare data and data-related software that improves efforts to collect, analyze and use data can also help in crafting more targeted initiatives to help those suffering from substance use disorder.

Fragmented Market, Efficiencies and Investment

Notwithstanding increases in mergers and acquisitions in the substance use disorder facility sector, it remains a fragmented one. The vast majority of substance use disorder treatment facilities in the country are still small and independent, with many operators running only 1-2 facilities. This generally presents substantial opportunities for significant efficiencies through consolidation and economies of scale. Consolidation through private equity investment, hospital/health system investment and/or by and among substance use disorder facilities themselves has the potential to result in additional resources for development of improved clinical standards and practices, implementation of health information technology, consistency of care across different treatment locations and negotiation of more favorable third-party reimbursement terms, among other things.

Legal Compliance and Regulatory Concerns

The following legal and regulatory issues are among the most material that must be considered in the acquisition of any substance use disorder facility.

Facility Licensure and Program Requirements

Substance use disorder facilities are generally licensed by state agencies depending on the scope of services provided. For example, facilities may be licensed to provide substance use disorder outpatient treatment, inpatient and residential treatment, or in some cases sober living recovery housing to patients. The type of license required can vary significantly from state to state. Upon a change of ownership, the buyer will likely submit a new facility application which may result in a survey of the facility, which may, in turn, bring to the surface areas of non-compliance with state licensing laws due to changes in the facility’s operations and changes in state law and oversight over time. Such circumstances can delay or derail transactions and give rise to related liabilities. And although not healthcare-specific, buyers and operators should also be mindful of real estate zoning restrictions and community relations that may impact operations and care. There are number of media reports describing incidents of tense community relations and alleged zoning violations where substance use disorder treatment and sober living facilities are located.


Many states regulate the marketing of substance use disorder facility services and products. For example, Florida prohibits making a false or misleading statement or providing false or misleading information about the provider’s or operator’s or third party’s products, goods, services, or geographical locations in its marketing, advertising materials, or media or on its website. Fl. Stat. § 397.55(1)(a). Additionally, Florida prohibits a provider from entering into a contract with a marketing provider who agrees to generate referrals or leads for the placement of patients through a call center or a web-based presence unless the substance use disorder provider discloses certain information to the prospective patient so that the patient can make an informed health care decision. Fl. Stat. § 397.55(1)(d). Other states have similar restrictions and several more are on the path toward enacting such restrictions. Governor Brown of California recently signed into law an anti-patient brokering bill that applies to licensed or certified alcohol and drug treatment facilities, their employees and certain related professionals. Given the expansion of insurance and federal health care program coverage for substance use disorders, these types of referral and marketing arrangements are much more likely to be subjected to increased scrutiny in the years ahead.

Staffing and Scope of Practice Issues

Many states prohibit the “corporate practice of medicine,” which is intended to prevent unlicensed persons from interfering with or influencing the physician’s professional judgment. Depending on the applicable state law, the corporate practice of medicine doctrine often prohibits, among other things, the employment of physicians and other licensed health practitioners by non-licensees, lay corporations and other legal entities that are not themselves licensed to practice medicine. It may also prohibit certain other actions by unlicensed individuals, including determining what diagnostic tests or treatment options are appropriate for a particular patient, hiring and firing (as it relates to clinical competency or proficiency) of other licensed providers, and being responsible for the ultimate overall care of the patient.

Additionally, depending on the type of substance use disorder facility, states may require licensed practitioners to hold certain clinical roles at a facility, be available for specific intervals during the day or for a determined number of days per week, and may also require that certain services or procedures have adequate physician supervision when provided to patients. Substance use disorder facilities are often required to engage a physician to act as its medical director and care must be taken in entering into that engagement to ensure that it is for valid services and in compliance with licensing, and potentially, payor requirements as well.

Some substance use disorder treatment providers may have initiated services many years ago with different and narrower levels of service that relied on a particular practitioner’s scope of license rather than an agency-issued facility license. Moreover, such substance use disorder treatment providers may have initiated services with a different corporate structure or no corporate structure, during a time in which relevant legal and regulatory requirements and oversight were significantly different than they are today. These matters often require careful examination during the due diligence phase of the transaction in order to help assess potential risk and, if needed, remedial measures related to corporate practice prohibitions and scope of practice limitations.

Confidentiality of Patient Records

Like many other health care entities, substance use disorder providers are subject to various state and federal laws relating to the privacy and security of certain patient information. The primary federal law that applies to health care organizations is the Health Insurance Portability and Accountability Act, as amended (HIPAA). HIPAA and its implementing regulations safeguard the use and disclosure of protected health information (PHI) held by covered entities, provide technical and administrative safeguards relating to the storage and confidentiality of PHI, and provide patients various rights with regard to access, accounting of disclosures, and more. HIPAA imposes significant liability on health care organizations for the unauthorized access, use or disclosure of patient medical records and other confidential information, and in certain instances HIPAA violations may result in the imposition of substantial civil monetary penalties by DHHS. States also regulate the use and disclosure of PHI (and other sensitive health and personal information) and may subject substance use disorder facilities to civil penalties for non-compliance with state laws.

Substance use disorder facilities also are subject generally to Title 42 of the Code of Federal Regulations (CFR) Part 2, which specifically relates to the confidentiality of substance use disorder patient records. Part 2 was enacted in 1975 to address concerns relating to the use of confidential substance use disorder records in non-clinical settings such as administrative or criminal proceedings, and provides separate, and generally, more restrictive use and disclosure requirements to certain federally assisted programs that hold themselves out as providing alcohol or drug abuse diagnosis, treatment, or referral for treatment.

Buyers should request copies of patient privacy policies, consent forms, logs, related compliance plans, training materials and any other document related to the use and disclosure of PHI prior to acquiring a substance use disorder facility to assess the strength of a facility’s compliance, potential for liability and any needed remedial action whether before or after concluding the transaction.

Reimbursement and Referrals

Entering contractual arrangements with commercial insurers and enrolling with federal health care programs is becoming more common and can help grow a substance use disorder facility’s patient base. However, contracting with these payors generally is accompanied by a number of compliance, oversight and administrative risks that might not otherwise apply to a private pay-only provider. Medicare and Medicaid impose certain “conditions of payment” and “conditions of participation,” among other billing and claim requirements. Similarly, commercial payors will each have individualized participation agreements including provisions relating to billing, claims, reimbursement, and other requirements applicable to the substance use disorder facility.

Depending on the payors from which a substance use disorder facility accepts reimbursement, there are a number of state and federal laws that prohibit certain payments in exchange for patient referrals. These laws can apply to arrangements with physicians, facilities, and even marketing companies. Substance use disorder facilities that participate in Medicare or Medicaid are subject to the federal Anti-Kickback Statute, which prohibits the offering or payment of remuneration for steering of patients to products or services that are reimbursable under federal or state health care programs. The Anti-Kickback Statute has been broadly interpreted to prohibit any payment if even one purpose of the payment is to induce the referral of covered goods or services, and violations of the Anti-Kickback Statute may also result in allegations of violations of the federal False Claims Act. These violations can result in significant civil penalties, exclusion from Medicare or Medicaid, and even criminal punishment.

Urinalysis and Clinical Laboratory Services

Urinalysis and other clinical laboratory services are often utilized by substance use disorder providers to ensure patients comply with their treatment programs. These tests are vital to providers as tools to monitor potential substance use disorders by patients, to help facilitate patient success and to help ensure the success of the substance use disorder treatment program as a whole.

However, payors, state agencies and local authorities are increasingly turning their gaze toward alleged fraudulent use of urinalysis tests and clinical labs as a means to extract considerable sums of payment from insurance companies. High profile media reports containing allegations and accounts of sober living homes and substance use disorder treatment providers being investigated or charged with a number of felonies for health-care fraud, insurance fraud and money laundering stemming from urine test billing schemes have cropped up in several areas across the country.

Clinical Laboratory Improvement Amendments of 1988 (CLIA) registration requirements may apply depending on how lab tests are performed and some states require additional licensing or registration for laboratory testing too, depending upon the scope and complexity of the tests.

Potential buyers of substance use disorder facilities should confirm if and how urinalysis and other clinical laboratory testing is performed and by whom to help assess compliance, licensure, and registration requirements. The frequency with which such tests are performed should also be reviewed to assess whether the amount of tests ordered appears to be within professional and sector norms for the type and size of the patient population, or whether it appears to be at outlier levels.

Transaction Considerations and Pitfalls

Specific Transaction Documents and Provisions

Each substance use disorder facility acquisition involves a core set of agreements that establish the basic framework for the transaction. These agreements typically include a non-disclosure agreement, a letter of intent and the asset purchase agreement itself (an asset purchase structure is assumed for purposes of this article). Depending on the circumstances, buyer and seller may enter into other ancillary agreements to facilitate the transaction, such as management agreements, employee lease agreements, and others to address any transitional or interim periods throughout the transaction. A more in depth review of common asset purchase agreement provisions, representations and warranties is available here.

Certain representations, warranties and other provisions that should be tailored in light of the potential risks identified above are highlighted below. They include but are not limited to:

  • Licenses and Permits. Given that substance use disorder facilities typically require some form of state license (e.g., a licensed residential drug treatment facility license), the purchase agreement should include a representation and warranty from the seller that the facility has all applicable licenses, that all such licenses are active, and that there are no deficiencies with respect to the licenses. In addition, with respect to facilities that do not require a license (e.g., in certain states, sober living facilities) the representation and warranty could specify that such facilities do not provide services that would require a facility license. Depending on the state and licensing requirements and parties’ expectations about the timing of the close of the transaction, an interim management and operations transfer agreement may be used to transfer the management to a new owner (but not the license) until a new license is issued to the new owner. However, care must be taken to ensure that state law permits such a structure and that the parties have appropriately allocated risk between them in these arrangements. Whether such an interim management structure is permissible can vary significantly from state to state, and even between different regulatory agencies within the same state.
  • Compliance with Laws. With the increased sources of reimbursement for substance use disorder services, there are a broader set of laws that apply to substance use disorder facilities, including potentially the federal Anti-Kickback Statute, state Medicaid anti-kickback statutes, and federal and state insurance fraud laws. In some states, insurance companies are particularly active in litigating allegations of fraudulent conduct. As a result, it is important for purchase agreements to include a “compliance with laws” representation and warranty, together with thorough due diligence, to help protect against the risk of a violation of law. Buyers may wish to expressly address certain risk scenarios discussed above in addition to more typical and general healthcare compliance representation and warranty language.
  • Staffing. As noted above, there are a number of potential issues at substance use disorder facilities involving employees or contractors, such as whether such people are appropriately licensed and acting within the scope of their practice, as well as ensuring that the facility does not run afoul of any state corporate practice of medicine doctrine. A representation and warranty focusing on employment and contracting issues, including corporate practice prohibition, scope of practice compliance as well as the compliance with laws representation and warranty discussed above, can help to allocate the risk.
  • Litigation/Investigations. The parties should include a representation and warranty regarding the status of any actual or threatened litigation or investigations. In recent years, there has been an increase in the number of lawsuits and investigations brought by insurance companies, regulatory agencies, and other private litigants alleging a wide variety of problematic conduct, including violations of Anti-Kickback and insurance fraud statutes, billing practices, unnecessary laboratory testing, and illegal/unethical marketing practices. A litigation/investigations representation and warranty can provide the buyer with information about these potential risks and a degree of protection against them. Sellers may opt to limit exposure through time limitations and knowledge qualifiers.
  • Billing Compliance. The purchase agreement should include a representation and warranty that the seller has billed applicable insurance programs (commercial insurance, Medicaid, etc.) in accordance with applicable laws, contractual obligations, and other applicable billing guidance. This is particularly important given the increase insurance coverage for substance use disorder treatments and the considerable resources that payors have to investigate suspicious billing practices, which they are exercising with increased frequency.

All of the foregoing, including due diligence review and appropriate contractual provisions, are important not only for compliance with law and mitigation/allocation of risk, but also bear upon quality of earnings and related value assessments of the treatment facility.

Conclusion and the Road Ahead

Although some improvements have been made, most people in need of behavioral health care, including substance use disorder treatment, are not receiving care or not receiving sufficient care. Due to the ongoing high profile opioid epidemic, ongoing regulatory changes, coverage expansion for substance use disorders, advances health technology that facilitate remote care, changes in societal attitudes about behavioral health and substance use disorders and the advantages to be gained by providers seeking strategic partnerships and investment, it is likely that acquisitions in this sector will remain hot for the foreseeable future. However, there are important legal and compliance risks that should be given careful consideration in connection with operating substance use disorder treatment facilities and in deals to acquire them. Greater consolidation and more private, commercial and government health care dollars flowing into substance use disorder treatment facilities will likely elevate the level of government and agency scrutiny. Careful planning in the early stages of the transaction, thorough due diligence review, sufficient description of key deal points, and well-considered use of material provisions in the key agreements noted above can be effective to help prevent transaction pitfalls.


Paul A. Gomez is a principal at Polsinelli LLP in Los Angeles. He has a health-care transactional and regulatory-based practice. He can be reached at pgomez@polsinelli.com. Rick Rifenbark is also a principal in the firm’s Los Angeles office. He advises clients on a wide range of health-care regulatory and transactional issues. He can be reached at rrifenbark@polsinelli.com. Ryan McAteer is a Polsinelli associate who focuses on health-care alignment, strategic affiliations, facility mergers and acquisitions, and other health care regulatory issues. He can be reached at rmcateer@polsinelli.com.

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