Carnahan Group Special Topics Review: CMS Final Rule – Commercial Reasonableness and Volume or Value of Referrals

Carnahan Group Special Topics Review

CMS Final Rule – Commercial Reasonableness and Volume or Value of Referrals

CMS Final Rule Commercial Reasonableness

March 2021



Commercial reasonableness has always been a condition of Stark Law and Anti-kickback Statute compliance requirements alongside that of fair market value.  The lack of a formal definition of commercial reasonableness challenged the implementation or standing of some health care financial relationships especially with regard to certain physician compensation arrangements. Parties to an arrangement may have been exposed to costly investigations or litigation should they have been perceived to have violated commercial reasonableness (i.e., compensating a physician above their professional revenues generated.)  One aspect of the Toumey case centered on commercial reasonableness in which the hospital provided part-time employed physicians with full-time benefits.

Based on regulatory commentary, health care organizations traditionally believed an arrangement was commercially reasonable, if, absent the volume or value of referrals, similar parties (of size and scope) believed an arrangement still made commercial sense. From a practical standpoint, this standard presented difficulties because so many arrangements involve parties with referral relationships that could not be easily separated as part of a compliance analysis. As a consequence, attorneys and valuation consultants developed tests with both objective and subjective criteria to help explain the commercial reasonableness of an arrangement. These tests sought to present evidence of a reasonable business case supporting an arrangement.  

New Definition

On November 20, 2020, CMS issued a formal definition of “commercially reasonable” at 42 C.F.R. § 411.351. Prior to the formal definition, “commercially reasonable” had not been defined in the regulatory text.  In the Final Rule commercially reasonable was defined to mean that “the particular arrangement furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.” Notably, the definition does not address the prohibition against varying compensation in relation to the volume or value of referrals.

Volume or Value of Referrals

Rather than including consideration of referrals in the new definition of commercial reasonableness, CMS issued new, separate Special Rules for compensation that “Take Into Account” the Volume or Value of Referrals. The rule outlined a condition in which the formula used for calculating compensation from an entity furnishing designated health services results in a positive correlation between compensation paid to a physician and either referrals from or other business generated by the physician. In other words, if compensation increases in relation to an increase in referrals (or other business generated) by a physician, the compensation will be considered to take into account the volume or value of referrals (or other business generated). The Special Rules also revise existing rules on Directed Referrals and the definition of Indirect Compensation Arrangements, which are not addressed in this Review.

Like the uncertainty around commercial reasonableness, the lack of a concrete definition of this important concept exposed providers to unnecessary costs and legal entanglements.  Thus, the new definition provides needed clarity for health organizations and their compliance advisors, and provides an objective test of “takes into account”.

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Moving Forward

While the new definition of commercial reasonableness shifts the analysis to be more subjective, Carnahan Group recommends that parties to an arrangement fully identify and document the factors supporting the arrangement’s business case. Importantly, the parties should affirm that the formula determining compensation does not result in a positive correlation between compensation and the volume or value of referrals.  And lastly, any financial losses incurred must be explainable and justifiable considering the arrangement objectives and environmental conditions.

Please contact Carnahan Group for additional information or a focused analysis of the commercial reasonableness of a particular arrangement and to learn more about CMS Final Rule Commercial Reasonableness and Volume or Value of Referrals

Prepared by John Michael Li and Daniel P. Stech, MBA, CMPE

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