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Preventative lease portfolio audits are worth a pound of cure

The potential for fines for non-compliant use of space arrangements, can range in the millions and warrants a critical review of real estate portfolios

By Allison Nelson / Special to Healthcare Facilities Today
January 23, 2020

In managing a healthcare organization, auditing a leasing portfolio may not be perceived as a priority.  The potential for fines for non-compliant use of space arrangements, however, can range in the millions and warrants a critical review of real estate portfolios.

The rationale for auditing 

1. Stark Law and anti-kickback statute violations

Space arrangements governed by the federal Stark Law or Anti-kickback Statute, or state corollaries, must be in writing and signed by both parties prior to space use, rent must be at fair market value, and the space must be accurately delineated.  While meeting these requirements seem simple, a myriad of issues may arise during the arrangement's life cycle which create compliance risk.

Using space prior to the agreement’s full execution or prior to obtaining the written consent of a ground lessor or lender, if consent is required, can be a non-compliant use of space.  

Drafting issues can also give rise to potential non-compliance.  Often an agreement fails to include a floor plan or provide accurate square footage measurements for the space.  Changes in space design, not using an architect to accurately measure the space, or relying on outdated floor plans are common deficiencies and using incorrect square footage to determine fair market value can result in an incorrect rent range. 

Incorrectly documented rent structures are also common.  For example, if the parties relied on an appraisal that established fair market rent assuming the landlord was providing all utilities at its cost, but the document was drafted so that the tenant was responsible for obtaining its own utilities, then the arrangement might be non-compliant.

During the lease term, changed circumstances can result in non-compliance.  A tenant or subtenant can "space creep" by using more space than originally permitted.  Parties may change which party contracts directly for services or utilities.  For example, the initial rent rate could be set as a full service rate with the landlord providing janitorial services, the cost of which is included as part of the initial rent rate.  If the tenant later decides to use its own janitorial services and if the parties fail to update rent to exclude the cost of janitorial services, then rent can fall outside of fair market value. 

Other changes in circumstances, such as relocation, expansion, or renovation of the premises or common areas, can alter square footage and, by extension, rent.  Agreements with evergreen or auto-renew provisions can become non-compliant if the rent rate falls outside of fair market value over-time.  

Incorrect payments or collections can also result in violations.  Operating expenses base year stops and gross-ups, rent abatement, annual escalators, tenant improvement allowances, offsets, holdover fees, rent or sales tax, and interest or late fees are often overlooked or incorrectly calculated.

2. Deliberate ignorance is dangerous

The Office of Inspector General's Health Care Fraud Prevention and Enforcement Action Team ("HEAT") warns that deliberate ignorance of issues is not acceptable and cautions organizations to implement proactive rather than reactive compliance programs.  It specifically cites "space creep" as a common violation.  The government is focused on lease issues and violations can be extremely expensive.

HEAT recommends creating a culture of compliance and cites fundamental components of proactive compliance programs, including establishing a compliance framework through adopting written policies and procedures, hiring compliance professionals, and engaging in effective training and communication.  It goes further, recommending internal monitoring and the establishment of enforcement standards and prompt response protocols. 

Components of a sound audit process

1. The initial audit

The initial real estate portfolio audit can be structured to identify individual undocumented use of space and non-compliant arrangements, as well as system deficiencies.

To identify undocumented use, engage in space surveys.  Space surveys should drill down on actual use by conducting virtual walk-throughs of space with operators.  Think about the everyday use of space.  Where does the physician get coffee and is this room part of the space the physician is permitted to use?  Does the physician use the adjacent conference room?  If the physician has a part-time sublease but stores records on site full-time, then does rent account for this full-time use?  These practical, simple questions can identify use that may not be apparent on first review of a floor plan.

Moving beyond the space audit, take a look at the documents in the contract database to ensure they are compliant.  Documents should be fully executed with floor plans.  Valuation support should be included in the file.  

Evaluate the lease life-cycle at all stages of negotiation and administration.  Confirm that the process for obtaining fair market valuations is consistent and independent.  Audits can be designed to review, at a macro level, the lease negotiation processes to determine whether sound real estate management principles are employed and involve persons with real estate expertise.

Ensure that systems are in place for tracking and monitoring commencement dates, auto-renewal dates, option terms, expiration dates, and other critical deadlines.  There should be sufficient time built into the process to confirm valuation prior to critical deadlines and to negotiate new rental rates, if necessary.  Determine whether there is a process in place to ensure changes in use occur only after documentation.  For instance, operators should know that a physician cannot take an additional exam room on Tuesday afternoon without first obtaining a written, signed amendment for the use of the space.

Through sampling, an audit can identify whether rent and operating expenses are being correctly charged, whether escalators are being applied and rent updated accordingly, and whether hold-over and other unique fees are being correctly imposed and invoiced. 

2. Process improvements

If a non-compliant arrangement is identified, legal analysis may be required to determine whether self-disclosure or refunding reimbursements is required, whether use of space or submission of claims needs to cease, and how to remediate the non-compliant arrangement.  

Upon identifying system deficiencies, correct them and improve the process by updating intake and arrangement forms and refining the document review process.  If an arrangement auto-renewed at a rate outside of fair market value, start tracking auto-renewal dates and require compliance review prior to renewal.  If numerous undocumented uses are discovered, train operators on when and why a written arrangement is required and create a system for reprimanding operators who intentionally allow non-compliant use of space and/or incentivizing operators who operate compliant facilities.  

3. Ongoing monitoring

After identifying issues through the initial audit and implementing process improvements, enact a process for ongoing monitoring.  As a first line of defense, ensure that when an arrangement is renewed or amended, it is reviewed for compliance.  Establish protocols for periodic space monitoring, such as requiring operators to periodically certify that the use of the space is still in accordance with the operative floor plan and arrangement terms.  In addition to space certifications, periodic audits or samplings of the accounting department's records can help confirm that rent payments have been properly billed and paid.  Track and monitor the types and frequency of identified issues, then make further process system improvements.  Compliance is an evolving and continual process.

Allison Nelson is a partner at Akerman LLP and Co-Deputy Chair of the firm’s Real Estate Practice Group. 




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