Recent Developments in Health Law


© 1999 - Haynes and Boone, LLP


  • Tax Court Backs IRS’ Denial of Tax-Exempt Status In Redlands Case - OIG Slams Gainsharing; IRS Initially (temporarily?) More Copasetic
  • Not All of a Hospital’s Physician Records Protected by State’s Peer Review Law
  • OIG Finalizes New Rule on Civil Money Penalties
  • Texas Attorney General Reviews Corporate Practice of Medicine . . . . Veterinary Medicine, That Is
  • FTC Suggests Attorney’s Sexual harassment Investigation Report Maw Be Subject to Fair Credit Reporting Act
  • Of Interest to Hospital Institutional Review Boards....


In a closely watched case, the U.S. Tax Court issued its long-awaited opinion in Redlands Surgical Services v. Commissioner of Internal Revenue (113 T.C. No. 3, July 19, 1999). Upholding the denial of tax-exempt status, the court adopted the IRS's emerging position that the lack of operating control of a joint venture between a nonprofit and a for-profit entity will be fatal to the nonprofit entity's tax-exempt status.

The joint venture between Redlands Surgical Services, Inc. ("Redlands") and the for-profit Surgical Care Affiliates, Inc. ("SCA") was proposed as a vehicle to acquire a 61 percent stake in an ambulatory surgical center, Inland Surgery Center, L.P. ("Inland ASC") a limited partnership. Redlands and SCA were to form a partnership (Redlands-ASC GP) that would be the general partner in the Inland ASC limited partnership. Redland's ownership interest in the general partner would be 46 percent, and Redlands and SCA would each be respresented in the partnership by two managing directors. In addition, a for-profit affiliate of SCA (SCA Management Co.) would have a 15-year management contract with the general partnership, renewable for two 5-year periods at the exclusive option of the management company.

The Tax Court agreed with the IRS that the proposed arrangement would not satisfy the requirement of Internal Revenue Code § 501(c)(3) that Redlands be "operated exclusively for . . . charitable . . . purposes." The court cited four major factors in support of its conclusion, of which the most important were those that related to control over the general partner and of its sole business, Inland ASC:

  • "Nothing in the General Partnership agreement, or in any of the other binding commitments relating to the operation of the Surgery Center, establishes an obligation that charitable purposes be put ahead of economic objectives in the Surgery Center's operation."
  • Redlands lacks voting control over the general partnership.
  • Redlands lacks any other formal control "over all matters other than medical standards and policies," as evidenced by the 2-2 split among the managing directors of the general partner; a binding arbitration clause to resolve deadlocks among the managing directors, which "does not significantly mitigate [Redland's] lack of majority control"; and a management contract that vests broad authority in the for-profit management company affiliated with SCA. Even in the area of medical practice and policies, which is assigned to a Medical Advisory Group, Redlands "lacks sufficient influence to determine the resolution of any matter brought before the Medical Advisory Group."
  • Redland lacks "significant informal control by which it exercises its influence with regard to the Surgery Center's activities."

The IRS' control requirement for joint ventures between for-profit and tax-exempt entities is also relected in Revenue Ruling 98-15, which the IRS issued shortly after denying Redlands Surgical's request for a tax exemption. Although the Tax Court never cited Revenue Ruling 98-15, it appears to have agreed with its premises and conclusions, finding support for the IRS' "control" requirement in the court's extensive review of common-law charitable trust decisions.

The Tax Court's 83-page opinion can be downloaded at: (requires Adobe Acrobat).

The Office of Inspector General of the Department of Health and Human Services recently dropped a bombshell on the industry by indicating its view that, as a general matter, gainsharing arrangements are statutorily prohibited. Federal law prohibits payments on behalf of a hospital that induce physicians to reduce or limit service to Medicare or Medicaid patients. The OIG's view is that gainsharing arrangements implement incentives to reduce or limit services and are therefore, per se, prohibited by this statute.

Moreover, the OIG suggests that clinical joint ventures, such as freestanding speciality hospitals, and units that are restructured as a separate hospital, may also be prohibited by this statute. The OIG hedges a bit in the pronouncement by saying "may" and "in at least some circumstances."

To read the OIG advisory bulletin, click on on the links below:

July 14, 1999, Federal Register

HTML version

PDF version

Original document

In contrast to the OIG, the Internal Revenue Service had earlier issued two Private Letter Ruling that approve the gainsharing arrangement between two hospitals and one or more cardiology group practices.  The arrangement approved by the IRS included the following features:

  • The physician group would be providing valuable services needed by the hospital.
  • The services provided by the physician group would result in tangible cost savings to the hospital.
  • The amount of the gainsharing benefit would be subject to a fair-market-value cap determined by an independent third-party appraiser.
  • The physician group would be subject to certain program integrity requirements to help ensure that the quality of care did not suffer.
  • Failure to meet either the cost savings goal or the quality criteria would result in no award pool.

This generally favorable response to a carefully constructed gainsharing arrangement contrasts quite markedly with the strongly negative statement from the OIG.  In early August, the head of the IRS' Exempt Organizations technical branch that deals with health care entities indicated that in the future, his office would consult with HHS on any gainsharing arrangement brought to the IRS' attention before issuing a ruling: "Unless that arrangement can be distinguished from the one that HHS has now said they have a problem with, we would be very reluctant to rule."

Finally, in early September the IRS released its "Exempt Organizations Continuing Professional Education Text for Fiscal Year 2000," which included a chapter on physician incentive compensation.  The IRS discusses twelve factors that it will consider in determining whether a given incentive compensation plan -- including gainsharing arrangements -- constitute private inurement or impermissible private benefit.   The IRS' discussion of these factors, together with its promise to consult with HHS, suggests that IRS approvals will be more difficult to obtain that its approach in the two Private Letter Rulings might have led many to believe.

A trial court recently ruled that medical malpractice plaintiffs are entitled to discovery of a physician's application for hospital privileges hospital because the application was generated in the ordinary course of business and contained information that was presumably available from other nonprivileged sources. Accordingly, the documents are not protected as peer review material by the state's peer review protection statute. The ruling came in a memorandum opinion in Philadelphia Common Pleas Court but has generated nationwide publicity and comment in health law circles.

Judge Mark I. Bernstein ruled in Pitts v. The Children's Hospital of Philadelphia that documents are non-discoverable under the Pennsylvania Peer Review Protection Act only if they are "prepared solely for the purpose of peer review and used only for peer review."

As is the case under Texas law, the Pennsylvania statute attempts to ensure the ability of the medical profession to police its ranks through a confidential peer review process by protecting from discovery, and prohibiting the introduction as evidence, any records or proceedings of a peer review committee. Thus, Judge Bernstein held that Makoske's performance evaluations, prepared solely for the purpose of peer review, were protected and not discoverable. However, Bernstein ruled that applications for medical staff privileges contained information presumably available from other sources and was not the type of information known only to the peer review committee and therefore should be discoverable.


On July 22 the Office of Inspector General of the Department of Health and Human Services issued a final rule that implements its broader authority to impose civil money penalties under the Balanced Budget Act of 1997.

Under the new rule, OIG can impose up to a $10,000 penalty against an institutional health care provider that employs or enters into contracts for medical services with individuals the provider knew or should have known were excluded from participation in Medicare and Medicaid. The preamble to the new rule provides a number of clarifications of the scope and effect of this provision, especially with respect to (i) the institutional provider's affirmative duty to determine whether employees and contractors have been excluded from the Medicare or Medicaid program and (ii) the applicability of the new rule to members of the medical staff who are not employees of the institution.

The rule also allows for the imposition of a penalty of up to $25,000 for failure to report information to the new Healthcare Integrity and Protection Data Bank, but the OIG indicated that it would not enforce this rule until it has issued a final rule governing the data bank in late 1999 (at the earliest).

Before the Balanced Budget Act was passed, violations of the antikickback provision could only be punished criminally or by exclusion from the program. Now OIG has authority to impose a penalty of up to $50,000 plus three times the total amount of remuneration (regardless whether any portion of the remuneration was for a lawful purpose).

Copies of the new regulation may be obtained by clicking on one of the links below:

July 22, 1999, Federal Register

HTML version

PDF version


In Opinion No. DM-498, dated December 22, 1998, in his review of a veterinary practice management arrangement, the Attorney General of Texas drew upon the corporate practice of [people] medicine. By implication, he left us with some lessons for the corporate practice doctrine itself, even though the Medical Practice Act and the Veterinary Licensing Act are phrased differently.

The attorney general addressed a management services arrangement whereby a corporation acquired a veterinary clinic's operating assets, including goodwill and patient records, and entered into a management arrangement with the veterinarian. The attorney general noted that the facts raise the specter of the unauthorized practice of veterinary medicine, but he cannot answer the question as a matter of law. The attorney general stated that patient and business records must be the sole property of the veterinarian and free from control of any unlicenced person, but this conclusion was based upon a specific provision in the Veterinary Licensing Act. The attorney general also declined to determine whether, as a matter of law, ownership of the "good will or trade name, either individually or in combination with ownership of other elements, would violate any provision of the act, although such ownership might be relevant to violations of it."

A veterinarian is not prohibited from adhering to a management services agreement, but drawing upon the corporate-practice analysis of the Dallas Court of Appeals in Flynn Brothers, Inc. v. First Medical Associates, the attorney general concluded that the "terms of any management agreement entered into by a veterinarian must be consistent with the act as a whole." In other words, the entirety of the facts and circumstances will make the determination.

The opinion notes that, while it is not a violation for the veterinarian either to pay for services on a percentage-of-receipts basis, or to sell, transfer, or assign accounts receivable, those actions in combination with other terms of the agreement might provide evidence that the management company is actually operating the practice. The corporation's control over the work schedule, fees, office staff and appointments with patients, and the establishment of drug protocols raise the possibility of such violations. Further, "factors such as payment for the veterinarian's employee benefits and withholding of his or her income and social security may also indicate that an employment relationship exists." Particularly noteworthy note is the attorney general's observation that the Veterinary Licensing Act can only be enforced against licensed individuals, so that actions against a corporation are not available. The Medical Practice Act is phrased in similar fashion, so the same conclusion may apply.

Opinion DM-498 is on the Attorney General's website at:


A Federal Trade Commission Opinion Letter issued in April 1999 suggests that reports of sexual harassment investigations by an employer's outside counsel are covered by the federal Fair Credit Reporting Act. The opinion states that under that statute, copies of the investigation reports must be furnished to the employee if the employer will be using it in making an employment-related decision. In reaching this conclusion, the FTC concludes that a non-employee who assembles information is a "consumer reporting agency." Other due process requirements may also be imposed under the act. The act provides for actual and punitive damages, together with attorneys' fees, for violations.

An employer may want to get permission from an accused harasser if its hires an outside investigator, or conduct the investigation with internal resources, perhaps using the outside experts for advice on how to conduct the investigation.

You can see the Opinion Letter at:

The National Institute of Health is responding to recent news reports of research subject abuse. The National Institutes of Health has proposed that the office that enforces federal regulations regarding human research, the Office for Protection from Research Risk (OPRR), be transferred out of NIH and into the Department of Health and Human Services. If OPRR is transferred to DHHS, we should expect an increase in OPRR's enforcement activities. Since compliance with NIH and FDA regulations regarding human-subject research is a condition of participation in Medicare, the reports of research abuse may result in greater survey resources being devoted to IRB's and stepped up enforcement, even if the proposed switch of OPRR does not occur. Indeed, there are signs that enforcement efforts are already on the rise. In 1999 alone, at least three major medical research centers have faced a variety of sanctions in response to lax record-keeping and oversight by the local IRB's.

We hope that you find this health law update useful. If you have questions regarding the update or any of the materials discussed in it, please contact one of our attorneys who are listed at the top of the document. We will welcome the opportunity to work with you in obtaining information about current health law developments as well as determining the impact these and related developments may have on your business.

Email Disclaimer