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The Federal Government Stumbles in Trying to Prove that McLaren Regional Medical Center Violated Stark II and the Anti-Kickback Statute

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Gary J. McRay
Foster Swift Health Law Report
March 2002

In June of 1997, a qui tam complaint was filed under the False Claims Act against McLaren Regional Medical Center (“McLaren”), Family Orthopedic Associates (“FOA”), and Family Orthopedic Realty, LLC (“FOR”).  The government eventually intervened, after dropping FOA as a defendant and adding five physicians individually, alleging that McLaren had paid the physicians, through FOR, payments in excess of fair market value in violation of the federal law commonly known as Stark II, 42 USC § 1395(a)(1), and the Anti-kickback Statute, 42 USC § 1320(a)-7b(b).  The government’s theory was that McLaren was willing to pay rental payments in excess of the fair market value in exchange for a referral of patients by these physicians to McLarens orthopedic/rehab center at the physician owned building known as Bristol III located in Flint Township.  The government was especially confident of this case because in 1995 FOR had appealed to the Michigan Tax Tribunal and had argued in the tax case that the FOR lease with McLaren was above market and therefore the McLaren rent was an inappropriate indicia of how valuable the property was for calculating its tax assessed value.  There were also allegations that FOR leased other space in the same building to other physician groups at rental rates below what was paid by McLaren.

After an eight-day bench trial in November of 2001, United States District Judge Patrick Duggan dismissed all claims against all defendants, concluding, (i) the lease agreement between defendant McLaren and defendant FOR was at arms-length, (ii) the lease rate was consistent with fair market value and (iii) there was no evidence that the lease rate was determined in a manner that took into account the value of potential patient referrals.  See Case No. 97-CV-72992-DT (US Dist Ct, ED Mich).  What this case demonstrates is that not only is fair market value a complicated unsure calculation, but it presents risks for hospitals and physicians as they attempt to comply with complicated federal statutes and a countervailing complication for the government if they actually attempt to provide a fair market value violation of the Anti-kickback Statute or Stark II.

The government relied on two expert witnesses.  Mr. Mark MacDermaid conducted a market rental study for the space in Bristol III leased by McLaren.  David Rexroth prepared the appraisal work that was used in connection with the Michigan Tax Tribunal case in 1996.  The court was critical of MacDermaid’s market study since he did not consider all comparable leases but only those comparable leases that were based upon gross or modified gross rent (apparently the McLaren lease was a gross rental per square foot lease), failing to consider comparable buildings leased on a net-net basis.  It is fairly easy to subtract certain costs associated with insurance, taxes, and utilities to convert a gross lease to a net-net lease.  The court was also critical of the Rexroth appraisal.  That appraisal did not include market comparables to reflect how the market rent was actually determined.

On the other hand, the court’s opinion pointed to the following favorable factors:

  1. McLaren and FOR negotiated their lease agreement over approximately nine months resulting in the lease favorable to McLaren because it had,
    1. a short 5-year term;
    2. lease space of only 21,315 square feet;
    3. although McLaren had the right to common areas, the lease square footage did not include any rental charge for the common areas;
    4. the leased premises was measured from the insides of the exterior walls and the center line of dividing walls rather than from the outside walls as was more typical of commercial leases;
    5. McLaren was not to be charged rent during renovations;
    6. the rental rate was only increased at 4% a year;
    7. McLaren was allowed to either purchase liability insurance coverage or self-insure; and
    8. McLaren had the option of providing a security deposit in cash or by promissory note.
  2. McLaren was the exclusive provider of physical therapy on the premises.
  3. FOR agreed not to own a physical therapy practice within 10 miles of the premises.
  4. FOR provided parking consistent with the business needs of McLaren.

The defendants produced three experts.  Their comprehensive studies demonstrated the fair market value of commercial office space and medical office space in Flint Township.  These studies were more complete than what the government had produced.  However, the most objective appraisals relied upon by the court were those prepared by a Mr. Wililam E. Boring who (1) appraised Bristol III in December of 1992, in connection with a potential sale and (ii) also reappraised this space in August of 1993 on behalf of Michigan National Bank.  The Boring appraisals supported the McLaren lease rate and the court felt justified in relying upon these appraisals since “the parties seeking and performing the appraisals had no preconceived position in mind with respect to the market rent for the building.”

Although the government argued that McLaren’s demand for exclusivity and the non-compete provisions of the lease demonstrated that the lease rate was “influenced by referrals,” the court disagreed, concluding that these lease provisions did not constitute evidence that the lease rate was determined in a manner that took into account any patient referrals.

This case demonstrates the confusion that occurs when federal statutes rely on a concept as broad as fair market value to determine either criminal liability under the Anti-kickback Statute or civil liability under Stark II.  Fair market value is always a range and hospitals that are attempting to fit themselves within safe harbors under the Anti-kickback Statute or Start II must document that they have achieved fair market value through contemporaneous appraisals, in order to protect themselves from being second-guessed at a later date by the federal government.