By Todd A. Rodriguez, Esq.

Published January 2008

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It was not long ago that many physicians saw the development of MRI and other freestanding diagnostic imaging centers as a perfect opportunity to recoup some of their practice net income lost to rising overhead and shrinking professional fee reimbursements. However, the imaging center boom has quickly gone bust and many physician-owned imaging centers are finding it difficult just to keep the lights on. Though the outlook for imaging centers is certainly bleak, all is not necessarily lost. Physician investors should consider a variety of options for turning their investments around, and even if the investment cannot be salvaged, should carefully develop a strategy to cut their losses to the extent possible.

A number of factors and market forces have converged in a veritable perfect storm over the diagnostic imaging industry. In the last several years, diagnostic equipment manufacturers, brokers and lenders, recognizing a demand in the physician market, were eager to sell equipment and make loans to start-up imaging centers – often based on overly-promising projections of referrals and quick investment returns. On top of this, with pressure from hospitals (the traditional outlet for diagnostic imaging services) and the perception that physician ownership must necessarily mean overutilization of services, many commercial insurance payors have begun imposing significantly heightened credentialing standards on freestanding imaging providers. In many cases, these standards now require that a freestanding imaging center have five or more modalities before it will be considered for participating provider status. The coup de grE2ce for the diagnostic imaging industry, of course, is the Deficit Reduction Act, which by some estimates has resulted in a reduction in Medicare reimbursement for diagnostic imaging services of as much as 30 percent. With shrinking Medicare reimbursements, burgeoning debt and only highly-leveraged rapidly-depreciating assets, many physician-owned imaging centers are quite simply on the brink of catastrophe.

The first step in deciding whether to try to bring an imaging center to profitability or simply try to cut losses, is to fully understand the center’s economic outlook. Having a firm grasp of the imaging center’s payor mix, referral sources and competition will help to define a picture of the center’s future prospects. For example, if the imaging center resides in a market where hospitals are purchasing primary care practices, and those practices represent key referral sources to the center, there may be little the center can do to stop those referrals from going to the hospital. Similarly, where a major payor to a center changes its credentialing standards to require additional modalities, unless the center has the financial wherewithal to accommodate and acquire those modalities, continuing the business may simply not be feasible.

Before giving up hope, however, physician investors should consider whether bringing in additional investors and/or capital partners could change their center’s outlook for the better. For example, selling an ownership interest in the center to a local hospital may give the center access to additional capital, modalities and negotiating clout. A hospital that has been lobbying against a freestanding imaging center with payors and referrals sources may quickly change its tune upon becoming an owner in that same center.

Where a freestanding center’s growth is stymied by lack of capital (e.g., inability to offer additional modalities) or management talent, a center may consider seeking investment from one of several national diagnostic imaging companies. Though physician investors may have to cede some management control, these large companies can bring much-needed capital resources, management talent and negotiating expertise to the table. While these options will result in a dilution of a physician investor’s ownership in the center, they may also result in bringing the center to profitability.

Many freestanding imaging centers have suffered because they simply never developed the physician referral base originally forecast during the start-up phase. Physician ownership in an imaging center may go a long way to cementing a physician’s allegiance to that center, but federal and state self-referral restrictions pose a challenge to centers seeking to offer ownership to referring physicians. Because most imaging services are considered "designated health services" subject to the federal Stark statute, many centers believe that they are prohibited outright from offering ownership to referring physicians.

However, the federal referral prohibitions of the Stark and anti-kickback statutes generally only apply to services covered by federally-funded payor programs. Accordingly, absent state law prohibitions, an imaging center may consider offering ownership to referring physicians on the condition that those physicians will not refer federal program patients to the center or any other investor in the center. Under such an arrangement, subject to state law, investing physicians may be permitted to refer commercial insurance and cash paying patients to the center without restriction. Of course, the regulatory framework within which these arrangements must be structured is quite complex, so proceeding with such an arrangement must be done with great care.

If after the above analysis physician investors determine that continuing to operate an imaging center is not feasible, careful planning should go into a strategy to cut investor losses and limit personal liability. Investors should, however, beware that when dealing with a languishing imaging center, time is of the essence. The longer the business is left to stagnate and decline, the more difficult it will be to either salvage it or liquidate it for any reasonable value. In addition, lenders holding personal guarantees may be much less willing to negotiate once the debt is in default.

As an initial matter, even while deciding on a liquidation strategy, every effort should be made to keep the center operating and if at all possible, growing. Certainly, selling a center with growing revenues is far easier than selling one with increasing losses. Moreover, a center that is hemorrhaging money usually works against its owners in sale negotiations since a purchaser’s bargaining power can grow in proportion to the owners’ losses. Accordingly, center owners seeking to liquidate should be wary of efforts by potential suitors to delay or drag out negotiations.

Next, investors must consider whether the center is more valuable as a going concern (which is typically the case) or on a piecemeal basis, and of course, whether there are readily available buyers in either case. If no one is in the market for a turn-key imaging center, the decision may be quite simple. Investors may have no choice but to try to maximize their liquidation value by selling the center in pieces to multiple buyers. For example, rather than chasing after a bankrupt business, imaging equipment manufacturers may be willing to take back and/or purchase the center’s equipment, particularly if they have buyers lined up for certain desirable used pieces of equipment. Similarly, local hospitals may be interested in specific items of equipment to complement their exiting operations or in the already-developed real estate as a means of expanding or renewing their outpatient presence.

Where investors have personally guaranteed the debts of the center, maximizing the value of the center’s assets is imperative. However, it will not always be possible to sell the assets at a price high enough to cover all of the center’s debt. Accordingly, investors with personal guarantees will need to approach their lenders to try to restructure the debt so as to minimize investor payment obligations. For example, lenders may be willing to finance each guarantor’s share of the debt over an extended period of time, thereby minimizing monthly payments.

There is little doubt that physician-owned imaging centers no longer hold the economic promise they once did for physicians. However, investors in failing centers are not always without options. With some careful planning and good advice, physicians may still be able to make their centers profitable, but if not, to at least minimize their personal exposure when turning out the lights and locking the doors.

Todd A. Rodriguez, Esq., is a health care attorney in the Chester County, Pennsylvania office of Fox Rothschild LLP.