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A good day for the state of Rhode Island

R.I. Attorney General Peter Neronha details the specifics of the deal approving the change of ownership of Prospect Medical Holdings

Photo by Richard Asinof

To ensure the future financial sustainability of Roger Williams Medical Center and Fatima Hospital in the ownership transfer of Prospect Medical Holdings, the R.I. Attorney General has imposed unprecedented conditions on the sale, including an $80 million escrow.

By Richard Asinof
Posted 6/7/21
In Part TWO, the full story of the conditions imposed by the R.I. Attorney General on the transfer of ownership of Prospect Medical Holdings are detailed, as if Attorney General Neronha was speaking directly to the reader.
What happens if the current business model for hospital-centric health care delivery systems is not sustainable? Why was the public relations team at Prospect Medical so silent in the wake of the Attorney General’s decision to approve the transfer, with an $80 million escrow account? Is there a way to quantify the contributions of the community health centers in Rhode Island in the delivery of health care? What is the opportunity for the new Prospect Medical Holdings entity to invest in an intervention similar to Clinica Esperanza’s initiative to provide care for uninsured residents instead of having them seeking their care at an emergency room?
As the initiative being directed by the Rhode Island Foundation develops its plans to make Rhode Island the healthiest state in the nation in 10 years, a very optimistic goal, it seems that there may be a need to look at the way that health care is financed at the health system level. What the R.I. Attorney General’s decision on the transfer of ownership at Prospect Medical Holdings reveals is that the function of private equity financing in health care seems to be done at the expense of the overall health of hospitals’ ability to survive as an enterprise. The question is: is there a better way to measure return on investment in how hospitals are run?

Part TWO

PROVIDENCE – In less than 40 minutes, R.I. Attorney General Peter Neronha delivered a master class on the financial problems with for-profit, private equity of financing of hospitals in Rhode Island, related to the transfer of ownership of Prospect Medical Holdings, a for-profit, California-based firm, in which the majority owners, Leonard Green Equity Partners, were seeking to sell their 60 percent share of the firm for some $12 million, to two individuals, Sam Lee and David Topper, who, as a result of the sale, would become the new, 100 percent owners of Roger Williams Medical Center and Our Lady of Fatima Hospital.

Neronha approved the sale – but only with the condition that an $80 million escrow fund be created to protect against future potential financial liabilities of Prospect Medical Holdings, which is faced with continuing losses in its operations, the need to pay back some $27 million in loans from the federal CARES Act, and debt liabilities of more than $100 million in a note due in July of 2022.

The financial expert hired by the R.I. Attorney General’s office concluded in his analysis: “While I do not believe that Prospect Medical Holdings faces a liquidity crisis in the next 12 months, I believe it will come sooner rather later, probably within 18 to 24 months.”

In response, by imposing conditions on the sale, including the $80 million in an escrow fund, R.I. Attorney General Peter Neronha said: “Now is the time to act.”

Here is a detailed transcription of the news conference held on Tuesday, June 1, which should serve as a primer on how to hold private equity firms accountable in the purchase, sale and consolidation of acute care community hospitals in Rhode Island.

A master class
NERONHA: We are here today to announce our decision in the application for change of ownership of the entity that owns Roger Williams Medical Center and Our Lady of Fatima Hospital.

Let me introduce the people who are with me today. On my left: Miriam Weizenbaum, the chief of our Civil Division; and Adi Goldstein, the Deputy Attorney General. On my right are Jessica Rider, Health Care Advocate, and Maria Lenz, who [works] in our Civil Division. All of them are terrific lawyers, and they have been integral to making today happen.

It has been a long process, but I think that today is a good day for the people of the state of Rhode Island, and in particular, the folks who work at, and most importantly, rely on Roger Williams and Fatima Hospital for their health care.

We have approved the change in ownership. However, that change in ownership is conditioned – and it is conditioned principally on things that I believe will ensure that the financial stability of those hospitals for at least the next five years.

That was really the critical issue for me, and this office, as we analyzed the transactions. It is a complex transaction, as all components of health care are. So, I’m going to go through today what those conditions are. And, I think, equally important, [to share with you] why we felt it was necessary to impose these unprecedented conditions;

Why we took the actions we did
NERONHA: I want the people of Rhode Island to understand why we took the actions we did. I think that it is important that they understand it. And, I think it is really important that the people of the state of Rhode Island pay close attention to health care and health care issues as we move forward, over the next months and years, because I can’t think of an issue more critical to the people of Rhode Island than health care.

We have imposed unprecedented conditions on this change of ownership in this proposed transaction. It includes $80 million guaranteed in escrow.

That means $80 million will be placed in an escrow account today that can be used as security to make sure that the commitments that are being made as a condition of this decision are kept by the new owners of Roger Williams and Fatima.

Those financial commitments are that the escrow provides financial security and stability are to ensure the continued viability and operations of Roger Williams and Fatima, to guarantee future investments.

A comprehensive review
Every hospital has to make investments every year, particularly in capital expenditures. And, it also ensures accountability on the part of the transacting parties.

The conditions that we are imposing today are the result of a yearlong comprehensive review of the state of these hospitals and the entity that owns them.

That investigation revealed financial vulnerabilities that threatened the viability of our hospitals over the next two years. And, it also revealed the root causes of those financial vulnerabilities.

The bottom line is that the transacting parties here have put shareholder profits before the financial security of these hospitals and their health care missions [emphasis added]. That review has informed the conditions that we have imposed today, and again, we will go through them in detail.

Once again, this is a complicated ownership situation and a complicated transaction. There are a lot of corporate entities involved here.

But, if you break it all down, there are really two things involved: There are our local hospitals and there is a California company that owns them. That company is Prospect Medical Holdings. [I’m going to refer to them sometimes as Prospect, sometimes as PMH.]

The ownership group
It is a California, for-profit health care company. It owns 17 hospitals across the country, including  two hospitals here in Rhode Island. It has owned Roger Williams Medical Center and Fatima Hospital since 2014.

It has two principal ownership groups: Leonard Green Equity Partners is a private equity firm based in California, and they own 60 percent. Samuel Lee and David Topper are two wealthy individuals, and they own the remaining 40 percent of Prospect.

Leonard Green is not a person. [Leonard Green was a person, but he is now deceased.] His entity, his private equity firm, now makes investments on behalf of its investors and its partners. Some of their investments include public pensions, endowments, foundations, corporate pensions and financial institutions.

They raise capital from investors and then invest that money in companies, seeking returns on their investments.

What’s critical here – which will go through in our presentation – is how Leonard Green managed to obtain those returns on their investments.

The transaction
The proposed transaction is this: Leonard Green wants to sell its 60 percent ownership interest to Lee and Topper.

The proposed price is $12 million, to be paid by Prospect Medical Holdings, not Sam Lee and David Topper.

And, Leonard Green, as a result of the transaction, would be absolved of $3.1 billion in PMH debt.

One thing that really got our attention when we were looking at this transaction initially was the purchase price.

Think about that purchase price for a minute. It’s 17 hospitals across the country and the purchase price is $12 million.

That’s a pretty low purchase price. [We bought the building next door for $6 million back in the day.] So, $12 million is a really small price to pay for 17 hospitals. And, that $3.1 billion debt is something that got our attention as well.

When the purchase is approved
When that purchase is approved, and it has been approved, Leonard Green Equity Partners is out. And Lee and Topper, through Prospect Medical Holdings, will now own 100 percent of Roger Williams and Fatima.

So, what this was about, from the very beginning, was: were there conditions under which we were going to let Leonard Green out? Leonard Green wanted out, and the question was, under what conditions.

The role of the Attorney General
Let’s talk about the role of the R.I. Attorney General as the state’s health care advocate, which sometimes is not altogether understood by everybody.

We have an obligation to ensure that a health care system in Rhode Island delivers quality, affordable and accessible health care to our residents. That is the operating principle under which we look at every single transaction.

Within that operating principle there are others: And one of them is to make sure that, as a result of any new approval that we grant, is that the new owners – and here we are talking about Lee and Topper – will make the minimum investments necessary.

This is [written] right into Rhode Island law to protect the assets and financial health and well being of Rhode Island hospitals – here being Roger Williams and Fatima.

I will tell you that to analyze that question, to get to the answers that would inform our decisions, to resolve the issues that we need to know to make an informed decision, that it has taken a tremendous amount of work by the health care team. The folks who are standing next to me are just part of the health care team in the office.

The health care mission has really expanded just in my first term here. There was a tremendous amount of work that was done to get to this day.

How private equity works
We requested and received thousands of pages of documents from the parties. We took statements under oath of 16 people; they included Lee and Topper, two Leonard Green partners, Alyse Wagner and John Baumer, that were involved in the running of Prospect. And, Jeffrey Liebman, CEO [of Prospect Medical] locally here in Rhode Island.

I want to talk a little bit about how Leonard Green works. For those who are not as familiar with how a private equity firm works, they actually become board members; they actually held the majority of seats on the board of the entity that owned our hospitals. So, private equity partners, with a majority of the board in California [were] the ones that ultimately owned our Rhode Island hospitals.

There was a public hearing in December via Zoom at which we reviewed a bunch of public written comments. I want to share with you what are the top-level conclusions as a result of that review.

Inescapable conclusions
The first was the inescapable conclusion that Roger Williams and Fatima have been and remain financially dependent on Prospect Medical Holdings.

The other conclusion is that Prospect Medical Holding is in a significantly less financially secure position today than when it purchased Roger Williams and Fatima back in 2014.

I want to focus in on how important that is that our hospitals here are dependent on PMH, and that PMH is not the same PMH it was back in 2014.

What we realized was that to ensure the independent financial security of our hospitals here, we needed to have strong conditions -- strong conditions that included a substantial amount of upfront money, money that we could count on, no matter what happened, in escrow or in an irrevocable letter of credit, to make sure that these hospitals would operate in the future.

The details
To get into the details a little bit, there were really two things that jumped out at me, and the team, as we looked at these hospitals and frankly, what they needed money for.

One was to cover operating losses. Roger Williams and Fatima had operating losses every year, and the reason for that involved the structure for how we do health care, which is beyond the scope of this press conference, but that’s the reality, not only for the last five years but going well back into time. Roger Williams and Fatima have run operating losses, which PMH has been covering.

It is also, as I mentioned earlier, necessary for hospitals to make capital investments every year. You need [to invest in] new technology, you need to renovate and expand, you need to buy practices; you need to continuously invest in your health care operations: That is the reality of every hospital in Rhode Island and across the country.

The reality here, too, is that Prospect has been paying for Roger Williams and Fatima’s capital investments every year to the tune of millions of dollars. Again, these are not conclusions that we reached out of the blue. The auditors at Roger Williams and Fatima themselves, the outside auditors, concluded that those hospitals were financially dependent on their parent companies. Here is a quote from the Carris Report, which is an exhibit to our decision. The Rhode Island hospitals are “totally dependent on” PMH, and are “not substantially viable” without support from PMH.

I am trying to drive the point home: that the financial health of PMH was really critical to us. The bottom line: As PMH goes, so go Roger Williams and Fatima [emphasis added].

Again, Roger Williams and Fatima are financially secure – only to the extent that PMH is financially secure.

Therefore, to approve this transaction, we needed to be confident that Roger Williams and Fatima would be independently financial secure as a result of this transaction.

Real concerns
Our review raised real concerns about that. As I said a moment ago, Prospect Medical Holdings was not in the same financial condition as they were when they purchased the Rhode Island hospitals back in 2014.

In 2017, Prospect’s assets exceeded its liabilities by $67 million. Today, their liabilities exceed their assets by over $1 billion. So, they went from $67 million to the good to $1 billion to the bad in four years.

And, I hope this explains the concern of this office in approving this transaction without strong conditions.

There are other causes for concern
Much of Prospect’s assets around the country have already been leveraged by being sold – and then being leased back. According to our expert, “PMH is a highly leveraged company that continues to have large annual losses.”

So what does this mean? What does it mean to sell your assets and then lease them back? What it means is pretty simple: when you don’t own your assets, it’s harder to raise money. You are in a weaker financial position.

How did we get here?
I am going to talk a little bit about how we got to this point. Prospect Medical Holdings board of directors consists of three Leonard Green Partners, Sam Lee, and David Topper.

And that board of directors has authorized financial transitions that have greatly benefited Mr. Lee, Mr. Topper, and Leonard Green and its investors – all the while selling and mortgaging PMH’s assets [most of its hospitals] – and increasing its debt by hundreds of millions of dollars.

Specifically, back in 2018, Lee, Topper, and Leonard Green, authorized a $457 million leveraged dividend recapitalization that substantially weakened the balance sheet of PMH. It benefited the shareholders of Leonard Green, it benefited Mr. Lee and it benefited Mr. Topper. But it didn’t benefit any of these hospitals.

Quite plainly, in 2018, they took out a $1.12 billion loan, they paid off some existing debt, and they paid $457 million in dividends to Lee, Topper, and Leonard Green partners and investors.

It got worse. In 2019, to pay down that debt and raise cash, PMH turned around and sold all but three of their hospitals to a real estate investment trust, MPT, for $1.4 billion, then leased them back for 15 years. PMH now no longer owns those facilities. They have fewer assets, so they less ability to borrow money.

Two Rhode Island hospitals and one California hospital were not sold and leased back in 2019. But in 2019, Prospect also borrowed $113 million from MPT, and that repayment is due next July [in 2022].

And, if there is one other thing, beyond what I’ve already talked about, which really got our attention: That our hospitals, Roger Williams and Fatima, next July, before the conditions that we imposed today, could have been sold and leased back to pay off that note.

So, next summer, Rhode Islanders could have woken up to learn that their hospitals, Roger Williams and Fatima, had been sold to pay off that $100 million indebtedness.

Additional causes for concern
Because of the COVID-19 pandemic, PMH, Roger Williams and Fatima have all received, collectively, hundreds of millions of dollars in federal CARES Act funds.

Some of those amounts are going to have to be paid back: $27 million is due from Roger Williams and Fatima hospitals; money that those hospitals don’t have. Remember, they run an operating loss every year; they are not in position to pay back the $27 million.

I wanted to share with you and the people of the state of Rhode Island our conclusions, in the words of our experts. I want the people of the state of Rhode Island to understand that when we undertake a regulatory review like this one, there’s a lot of expertise standing next o me up here, but we also retain experts that can really help us understand what’s going on behind the curtain.

In the words of our experts, here is a recap:

PMH is a highly leveraged company that continues to have large annual losses.

• Their liabilities exceed their assets by over $1 billion, and their cumulative losses exceed $600 million for the six-year period under review.

• The current owners issued over $500 million in dividends since PMH purchased the Rhode Island hospitals that benefited the shareholders and weakened the financial position of PMH.

• They sold substantially all of its real property except for one California hospital and the Rhode Island properties. There is very little leverage to provide liquidity.

• Their growth has been primary funded through debt and the sale-leaseback of certain properties to MPT.

• Leonard Green has been a net drain on PMH’s assets.

• Management seems to be relying on debt and a $200 million line of credit to fund the company. However, there is no guarantee that lending institutions will leave that facility in place if losses continue to mount and there is not profitability forecasted.

More significant concerns
What has caused me significant concern, six to eight weeks ago, was that our expert concluded that while he did not believe that PMH faced a liquidity crisis in the next 12 months, he believed that it would come sooner rather than later, probably within 18 to 24 months.

That’s a crisis on our doorstep. And we needed to address it. Our experts state that Prospect Medical Holdings cannot to continue to have significant operating losses and fund necessary capital projects and expect to survive long-term.

The situation is complicated by the TRS note [that’s the indebtedness I mentioned a moment ago], through which the Rhode Island hospitals can be sold and leased back to pay off that debt, which is due in July of 2022, and the fact that most of the real property has already been sold to MBT.

We needed to act now, not later
So, what was our takeaway? Our takeaway was that we needed to act now, not later.

We couldn’t just approve this transaction based upon the promises of Lee and Topper, the new owners, that they would do the right thing.

That they would cover the operating losses; that they would make the capital investments that are necessary, that they would resolve the TRS note in a way that didn’t involve the selling and lease back of our hospitals, that they would pay the $27 million [in CARES Act loans] that was going to be due, [an expense] that these hospitals can’t afford to pay.

It was pretty clear to me then, and it is clear to me today, that relying on those promises alone was not going to be enough. And, that it was our responsibility to the people of the state to make sure that the money was there now, not later, so that these hospitals would survive.

If the storm hits
We needed the security, to put it bluntly, that there would be committed, up-front money that we know will be there, if the storm hits. Money that will be in escrow, or an irrevocable letter of credit, that cannot be reached by the parties, that if, and I hope it doesn’t happen, that if PMH goes into bankruptcy, [the funds] can’t be reached in bankruptcy.

It’s money that these hospitals can rely on to do what they need to do to serve the people of Rhode Island. So, the $80 million in escrow, that will [be deposited] today, before the transaction closes, $80 million up front to provide the security I mentioned.

To cover operating expenses and capital expenditures for the next five years, and to pay back the $27 million in the federal CARES Act relief funds owed by Roger Williams and Fatima hospitals.

Moving parts
There are a lot of moving parts here, so I will go over them pretty quickly.

The $80 million in escrow breaks down like this:

• There is $12 million in what we called the “Global Conditions Escrow” to cover in a very broad way, frankly, what we think needs to be covered.

• There’s $41 million in the CapEx escrow, which covers, as you may be able to tell from the name, capital expenditures.

• And there’s $27 million in the MAAP escrow, which covers the $27 million indebtedness that we are concerned about from the CARES Act money.

What’s also important is that some of this money is coming form Leonard Green. I thought that it was important that Leonard Green have skin in the game, even though they are walking out the door. They are funding a substantial portion of the escrow.

The bottom line is: If these entities don’t do what they are committed to do, if they don’t cover those operating costs, if they don’t make the capital investments, if they don’t give the $27 million in CARES money back, then they don’t get their money in escrow back, and Leonard Green doesn’t get its money either.

These escrows are security to make sure that those commitments are kept.

Payment schedule
The schedule includes the condition that at least $12 million must be spent by the end of the fiscal year at Rogers Williams and Fatima hospitals.

And, over the next five years, at least $60 million must be spent, at least $10 million per year.

I want to make this really clear: these are real capital expenditure. One thing that I have learned in the course of this job is that if we don’t make sure it is real capital expenditure, meaning a real investment in something that you can see or touch, that can really impact the people of the state, then it is not a capital expenditure, in my mind.

There are ways to play with that phrase or that term that does not result in the kind of investment that is warranted. We are very careful to define our capital expenditures conditions as requiring real money.

As I mentioned before, [the funds that are being held] in escrow can only be drawn down by Leonard Green and Prospect if they meet their commitments.

If they meet them, if they invested the money that those escrows are designed to secure, they can draw the money down; if they don’t, they don’t get it back.

Leonard Green is contributing more than $34 million of the $80 million in the security By participating, Leonard Green has an incentive to make sure that Prospect keeps its commitments.

Again, if Prospect doesn’t, Leonard Green doesn’t get its money back.

Other important conditions
Also, as a condition of approval of this transaction, we made sure that our Rhode Island hospitals could not be sold and leased back to pay back that $113 million in debt next July.

That kind of deal cannot be considered for five years under the terms of this decision, and, if it is considered thereafter, nevertheless, it has to be approved by this office.

You will see in the decision something that is referred to as PACE financing debt.

PACE financing are loans that can be taken out to make smart energy investments in hospitals.

The hospitals here have taken out $60 million in loans to make those investments in addition to the capital expenditures,

As a condition of this decision, PMH must guarantee that debt – all $60 million it. There is $27 million of it sitting in escrow right now that has to be used toward the $72 million in overall capital expenditures that we are requiring.

Management fees
The next [concern] goes to management fees. In the past, our local hospitals had been charged management fees. Those were about $7 million a year. Those $7 million a year management fees contributed to the annual operating losses at the hospitals.

As a condition of this decision, we required Prospect not to charge the local hospitals those management fees. Which will reduce the operating loss, to the extent that there is one. To the extent that there is one going forward, it will reduce that operating loss number.

When you get through all of the financial conditions, I think that of all of the financial conditions, the one that people who receive their health care at Roger Williams and Fatima and the people who work there will care the most about is this: For the next five years, Prospect must keep Roger Williams and Fatima hospitals open and operational.

What does that mean? They are required to maintain and continue the full complement of existing essential health services at Roger Williams and at Fatima. What that means is that they have to keep doing what they are doing. The bottom line is, that for the next five years, they need to keep doing what they are doing, and the money is in the bank to make sure that they do.

They’ve got to continue to guarantee the funding of the Roger Williams and Fatima hospitals’ 401[K] retirement plans. They’ve got to continue to provide charity care, consistent with the state law.

Fiduciary responsibility of board members
We’re requiring them to have local members on the board; we’re also requiring that they have Sam Lee on the board. Now, as you recall, Sam Lee will be on of the two owners of the big company out in California. Why do we want him on the Rhode Island board?

We want him on the Rhode Island board because when he serves on the Rhode Island board he owes a fiduciary duty to these hospitals. And, that is something in the course of our review troubled me greatly. It troubled me that the local board was not aware of some of these issues we are talking about today.

And, it also troubled me, as I tried to analyze what exactly Mr. Lee’s fiduciary responsibility was to our Rhode Island hospitals, one of the things that concerned me was that he was not on the local board of directors.

So, now he will be. And, he owes a fiduciary duty to these hospitals to make sure that they are operating in a way that is financially stable and delivering quality health care. Fiduciary duty is a legal term; what it means is you owe a duty of care to the entity that you serve. And, it means their interest is more important than your financial interest. That’s really important, particularly in health care.

We’re going to monitor this transaction and its conditions we are imposing today very closely, as you might expect. And we have extended [our review] beyond the five-year review under the Hospital Conversions Act by a little bit more, until Sept. 30, 2025.

Through these conditions, we have made these hospitals as secure as we can make them. We’ve got cash on hand that the owners can’t reach, so if something goes wrong, we can make sure that they continue to operate in a productive and an effective way. It is going to make sure that that we hold the new owners to their promises.


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