Hogan & Hartson Llp

Hogan & Hartson llp

MEMORANDUM

November 30, 2007

In a decision issued last week, a New Jersey state court found that physician ownership in an ambulatory surgery center (ASC) to which an investing physician refers patients is prohibited by New Jersey’s state self-referral law, commonly referred to as the “Codey Act.” The case, Garcia v. Health Net of New Jersey, involved a payment dispute between a group of physicians and their affiliated ASC, on the one hand, and a commercial insurance carrier. Specifically, the insurer claimed that the physicians’ referrals to their ASC were prohibited by the Codey Act – New Jersey’s state law version of the federal Stark law – so that claims submitted by the ASC to the insurer were unlawful and in violation of state insurance fraud laws. Although the court ultimately held that the ASC and physicians were not liable to the insurer for damages or penalties because they did not “knowingly” violate the Codey Act, its decision that the law was violated nevertheless has serious ramifications for physician ownership of ASCs in New Jersey.

To better understand those ramifications, it is helpful to begin with some background on the Codey Act. The law was adopted in 1991, at the same time approximately half the states were enacting physician self-referral prohibitions modeled on the federal Stark law (which was first adopted in 1989). The New Jersey law is similar to Stark and to other state self-referral laws in that it broadly prohibits a physician from referring patients for certain health care services to an entity in which the physician has a financial interest. The New Jersey law is unique, however, in one important respect – while Stark and the other state “mini-Stark” laws make clear that ASC services are not among the so-called “designated health services” subject to their self-referral prohibitions, the New Jersey Codey Act specifically includes “a facility which provides…ambulatory surgery” among its covered health care services. As a result, looking only at the language of the statute, it would appear that New Jersey law does, in fact, prohibit physicians from referring patients to ASCs in which they have an ownership interest.

Yet, the Codey Act has not deterred the development of physician-owned ASCs in New Jersey because the New Jersey Board of Medical Examiners – the state agency charged with enforcing the law – has, for many years, taken the position that the law does not apply to physician ownership of ASCs. In particular, in 1997 the Board issued a widely-publicized advisory opinion broadly interpreting an exception in the Codey Act for services provided at a physician’s office to support its conclusion that a surgeon’s referral of his or her own patients to an ASC was not an impermissible self-referral. In that opinion, the Board stated that its “rationale for allowing a self-referral in this context is that the service offered is so integral to the practice of the surgeon that it may be perceived as an extension of his/her medical practice.” Largely in reliance on this opinion, physician ownership of ASCs is common in New Jersey today.

As you might guess, the physicians and ASC in the Garcia case relied heavily on the Board’s 1997 advisory opinion to rebut the insurer’s allegations that their claims for ASC services violated the Codey Act and, as a consequence of that violation, were subject to damages and penalties under the New Jersey Insurance Fraud Protection Act (NJIFPA). The court rejected the ASC’s argument, however, finding the Board’s advisory opinion non-binding and distinguishable from the case at hand because it dealt with a hospital-physician joint venture. More importantly, the court concluded that “the language of the statute is plain and simple, and can yield no other conclusion but that the defendant-doctors’ referrals of their private patients to the ambulatory surgical center, in which each of them has a significant beneficial interest, runs afoul of the Codey Act ban on such referrals.” Moreover, the court rejected the Board’s extension of practice rationale, saying that “[s]imply calling the Center the doctor’s office does not advance the analysis and, instead, eviscerates the plain language of the Codey Act.”

Despite these conclusions, the court acknowledged that physician ownership of ASCs in New Jersey “is indeed widespread, and the enforcing authorities are indeed well aware of it and have taken no steps to halt the practice or prosecute the practitioners.” As a result, “the doctors – and, by extension, the Center – reasonably believed the arrangement to be lawful,” according to the court’s opinion. Therefore, the court ultimately held that because the physicians and ASC did not knowingly violate the law, they were not liable for damages or penalties under the NJIFPA or other state laws.

While the end result of the Garcia case was a win for the ASC and its physician owners, the court’s Codey Act findings now raise serious doubts about the future of physician ownership of ASCs in New Jersey. We should note that the Garcia decision is a trial court ruling – as opposed to an appellate court decision – and thus is not binding precedent for other New Jersey courts. Still, given the statute’s wording, the court’s reasoning is undeniably persuasive and could be followed by other trial or appellate courts in New Jersey.

We have learned that for the past year, the New Jersey Board of Medical Examiners has been considering regulations that, among other things, would codify its 1997 advisory opinion by establishing an express regulatory exception to the Codey Act for physician ownership of ASCs. In light of the Garcia decision, hopefully the Board can be persuaded to expedite the issuance of those regulations. It also would be helpful if, in the meantime, the Board would state publicly that it does not intend to enforce the Codey Act against ASCs pending the adoption of final regulations. Notably, the court in Garcia found that only the Board has the authority to seek penalties under the Codey Act, which provides for civil money penalties of up to $20,000 for each violation. Thus, a statement from the Board, followed by the adoption of formal regulations confirming its historical interpretation of the Codey Act, would go a long way towards reassuring ASCs that physician ownership is lawful in New Jersey. It would appear that FASA could play an instrumental role in helping to achieve that result.

Regulatory action alone, however, may not be sufficient to firmly secure the legality of physician ownership of ASCs in New Jersey. This is because state agencies, like the Board of Medical Examiners, do not have the legal authority to adopt regulations that are contrary to, or inconsistent with, a statute enacted by the state legislature. In simple terms, an agency cannot rewrite a statute through regulations. With that in mind, it is particularly noteworthy that the Garcia court found an exception for physician ownership of ASCs was not supported by the plain language of the Codey Act. As a consequence of that holding, it is possible that the Board will now conclude that it no longer has the legal authority to pursue its regulations. Moreover, even if the Board goes forward with adopting a regulatory exception, those regulations would be subject to legal challenge. The principal concern here is not enforcement actions from the Board – assuming it does not completely reverse its historical position – but legal action by insurers, who may argue that the Garcia case now puts ASCs in New Jersey on notice that physician ownership is prohibited by the Codey Act and, thus, provides a basis for future insurance fraud claims for “knowing” violations. A challenge to the regulations from hospital interests also is possible. Therefore, legislation to amend the Codey Act is the only sure way to ensure that physician ownership of ASCs in New Jersey is on solid legal ground.

Meanwhile, the Garcia case presentsa real dilemma for physician-owned ASCs in New Jersey. They are not out of business, but they definitely are in for a prolonged period of significant uncertainty. If the Board were to come out with a strong statement indicating it intends to adopt regulations to continue permitting physician ownershipof ASCs, hopefully that – along with the fact that the insurer in this case ultimately lost – would be enough to dissuade insurers from suing ASCs in New Jersey while a longer term legislative fix is pursued. As for the risk of insurer litigation, it is noteworthy that the insurer in the Garcia case alleged that the ASC intentionally elected to bill out-of-network in order to obtain “inflated” facility fee reimbursement, which apparently was the primary motivation for the litigation. Thus, ASCs in New Jersey concerned about the risk of insurer litigation may want to consider limiting their charges to insurers to network rates, thereby eliminating much of the incentive any insurer would have for pursuing legal action.

Finally, it also is worth noting that a separate aspect of the Garcia case involved a claim by the insurer that the ASC’s practice of not collecting out-of-network coinsurance from patients violated NJIFPA and other state laws. The court rejected that claim as well, despite prior case law in New Jersey finding the routine waiver of co-payments and deductibles a deceptive trade practice. In an interesting development on this topic, the court distinguished “in-network” co-payments and deductibles from “out-of-network” coinsurance, holding that where a provider is out-of-network and has never represented to an insurer that it collects coinsurance, the provider’s decision to not pursue collection from patients is not fraudulent nor unlawful.

I would be happy to discuss the Garcia case and its implications with the Committee and answer any questions you may have.

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