Private Equity & British Care Homes

In earlier posts I have discussed the “care/profit tradeoff in nursing homes,” focusing on the role of private equity firms in reducing costs by limiting the liability of their enterprises. Cutting nursing staff and increasing the risk of elder neglect isn’t so costly for private equity barons when “complex corporate structures . . . obscure who controls their nursing homes.” One firm constructed a particularly notable series of corporate moats between itself and the nursing home which it first controlled, and then rented land to.

Daniel JH Greenwood has called a good deal of private equity activity a form of looting, and I have explored its shortcomings in a review of a book on the topic. Sadly, it appears that the private equity influence in Britain is undermining a key part of its health care system. Having stacked various care homes with debt in order to buy them, many private equity firms have abandoned (or are about to abandon) the homes:

[A new] report, delving into the running and funding of the care industry, reveals that the collapse of Southern Cross may not be a one-off, as a number of other social care companies are also on the brink. Private equity takeovers of public services that use similar high risk business models, could leave taxpayers picking up the bill for more company failures. The in-depth study of privatisation shows that the second largest care provider, Four Season, is also in severe financial difficulties and others may follow. If both Southern Cross and Four Seasons were to collapse, around 1,150 nursing and residential care homes would be at risk of closure, affecting nearly 50,000 vulnerable people and their families and hitting over 60,000 staff.

Another of the top four largest residential care home operators is Barchester Healthcare — a sister company to Castlebeck, the operators of the Bristol care home exposed by a Panorama documentary . . . for patient abuse. The home owners have admitted that serious wrongdoing took place at Bristol. The report shows that Barchester and other operators of care homes, have repeatedly changed ownership, often through private equity firms buying, consolidating and selling companies. The UK’s largest union is warning that the Government must tackle the crisis in the care industry.

However disruptive the private equity takeovers have been, they have fulfilled their main purpose: huge gains for a few entities that bought and sold at the right time:

Southern Cross was floated on the stock market by Blackstone, which obtained a 400% return in two years on its acquisition. Southern Cross is now at risk of collapse. Allianz Capital Partners made a return of 100% by acquiring Four Seasons in 2004 for £775 million, selling it four years later for £1.4bn - the business then collapsed in value.

3i private equity fund brought a 38% stake in Care Principles for £1.5m in 1997, the remaining amount in 2005 and sold to to Three Delta in 2007 for £270m — a return of 390%. Tunstall was acquired by Bridgepoint Capital in 2005 for £225m, merged with Bridgepoint Investment and sold on after three years for £514m.

Here are more details on Southern Cross. This story and other critical commentary suggest that the goal for owners has been rapid profit rather long term investment in more efficient processes. When the “music stopped” in the acquisition game, it was left with mounting debts.

Chris Sagers’ article “The Myth of Privatization” (59 Admin. L. Rev. 37) suggests that there is very little difference between “public” and “private” operationally, except that “one of them lacks even a nominal obligation toward the public interest.” I have seen little evidence to contradict that idea in the eldercare industry. Further research may reveal more support for Daniel JH Greenwood’s diagnosis of the rise of private equity:

The success of private equity firms challenges mainstream corporate governance theory: according to standard agency cost analysis, this should not have happened. Agency problems—the shorthand term for the tendency of fiduciaries in a capitalist system to work for themselves as well as, or instead of, their clients—cannot be solved by adding an additional layer of extremely highly paid agents supported by an ideology that justifies the most extreme forms of self-interestedness. Therefore, private equity is unlikely to be an innovative solution to the age-old agency problem.

Instead, it is better understood as a clever bit of legal arbitrage: by reclassifying agents as principals, it allows former fiduciaries to instead view themselves, and be viewed by others, as entitled to look out only for themselves. And look out for themselves they have: the private equity managers have extracted hitherto unseen sums from our corporations, appropriating for the private benefit of a handful of individuals surplus that otherwise might have gone to other corporate participants, including consumers, ordinary employees, taxpayers and investors in the public securities markets, or might have been devoted to increasing productivity or innovation for the benefit of future generations.

The basic private equity technique, like the basic hedge fund technique, appears to be to borrow money in order to increase potential returns or losses. If the loans were correctly priced, this would not create new value under standard valuation theories, nor would it be a service that could possibly warrant the high fees typically charged in the hedge fund and private equity worlds. The simplest explanation is that either lenders or fund investors are mispricing risk and have done so for several years at a stretch, contrary to the claims of the efficient market theorists.

This explanation suggests, moreover, that private equity is simply the modern equivalent of the pyramid schemes, margin loans and highly leveraged utility holding companies of the 1920s. Like those earlier edifices built on borrowed money, the contemporary schemes are likely to be highly unstable: if the underlying assets decline in value or fail to provide expected income by even small margins, the lenders are likely to take losses out of scale with their potential profits. Once lenders wake up to this possibility—most likely only after losses have begun—they are likely to cut back lending rapidly, which will, in turn, make the underlying assets both less valuable and less saleable still, thus beginning a new round of lender panic. Any minor downturn, in short, runs the risk of starting a self-reinforcing cycle of credit and business contraction. The rise of private equity in its present form, then, appears to be another step towards the pre-New Deal world of inequality and instability.

And don’t forget about the role of private equity in influencing our political process. Blackstone billionaire Pete Peterson helped fuel concerns about government spending, while doing very little to advocate for increased taxes on the wealthy. And now we see that the CLASS Act—an innovative program to promote full funding for future long-term-care in the US–is likely to be on the chopping block. The primary value of both care homes and care plans to P/E firms appears to be their susceptibility to rapid sales and purchases. The P/E firm’s employees can earn massive bonuses if the value of entities goes up, and can’t lose those bonuses even if things eventually fall apart. It is a heads they win, tails they win scenario. The losers include all the other stakeholders in firms which are treated primarily as ATMs for fleeting owners.

Third Circuit Recognizes Federal Civil Rights Action for Death Caused by Substandard Nursing Home Care

Viejos Comiendo Sopa, Francisco de Goya, 1819-1823

[Ed. note: Today's post comes from Danielle Y. Alvarez. She is a Seton Hall Law student and a graduate of NYU, where she majored in Political Science. Ms. Alvarez is a research assistant to Dean Kathleen M. Boozang, and a former legal assistant to the Augulius Law firm.]

State and federal legislatures won’t fix the health care system by themselves, which is why a recent Third Circuit decision is a welcome tool to fight substandard long-term residential care.  A few enforcement officials have been aggressively creative in using false claims act theories to pursue providers of substandard health care (See here and here).  In short, the government claims that the submission of a bill to Medicare for services that were so bad they were the equivalent of no care at all is a false claim for which the government should be reimbursed and recover penalties.  And now the Third Circuit has recognized that the provision of such substandard care violates an individual’s civil rights.

In Grammer v. Kane, a nursing home resident’s child sued the nursing home, operated by Allegheny County in Pittsburgh, Pennsylvania, alleging the home’s failure to provide adequate care caused her mother to develop ulcers, become malnourished and develop sepsis, from which she died. Plaintiff invoked  42 U.S.C. §1983 to argue that the nursing home had violated decedent’s civil rights by breaching a duty to provide the standards of care delineated by the Federal Nursing Home Reform Amendments (FNRA), contained in the Omnibus Budget Reconciliation Act of 1987 (OBRA). The district court granted the nursing home’s  motion to dismiss, finding that FNRA merely sets forth requirements for nursing homes to comply with but does not grant the deceased rights that are enforceable under §1983. The United States Court of Appeals for the Third Circuit reversed and remanded, concluding that FNRA grants Medicaid recipients like the deceased rights whose violation can be remedied under §1983.

Congress passed FNRA in 1987 to address the substandard conditions in nursing homes that participated in the Medicare and Medicaid programs. FNRA sets forth various quality and residents’ rights standards to which the nursing homes must adhere in order to be paid by the federal government.  And yet, as everyone knows, the problems persist. And so it should be a welcome outcome that the Third Circuit held that FNRA unambiguously confers federal rights upon Medicaid recipients in nursing homes, which gives rise to an action under §1983 which imposes liability on every person who, under color of state law, deprives another of “rights, privileges, or immunities secured by the Constitution and laws.” 42 U.S.C. §1983 (2009).

To determine that FNRA affords protection under §1983, the court applied a three factor test set forth by the Supreme Court in Blessing: first, the court determined that Congress intended FNRA to protect personal rights of Medicaid beneficiaries and nursing home residents rather than the nursing homes themselves; second, the court found that the rights asserted are not so “vague or amorphous” that their enforcement would strain judicial resources; third, the court concluded that the statutory language is sufficiently mandatory in nature with its repeated use of “must” such as “a nursing facility must provide services and activities to attain or maintain the highest practicable physical, mental and psychosocial well-being of each resident.” See Blessing v. Freestone, 520 U.S. 329 (1997); 42 U.S.C. §1396r(b)(2)(A) (emphasis added). Furthermore, the court found Congressional intent to create a right of action through rights-creating language, legislative history, statutory structure and Congress’ failure to set forth a more comprehensive remedial scheme. Thus, the Third Circuit recognized individual rights conferred by FNRA that are presumably enforceable under §1983.

District Judge Stafford, sitting by designation, wrote a dissenting opinion finding that FNRA is Spending Clause legislation which does not confer upon funding beneficiaries individual rights to sue funding recipients. The dissent highlighted specific statutory language to conclude that FNRA focuses on what nursing homes must do in order to receive federal funds rather than focusing on the individuals who benefit from the federal funds. Absent unambiguous Congressional intent to the contrary, FNRA does not grant nursing home residents individual rights to sue nursing homes under §1983 for alleged violations of FNRA. As such, the dissent argued that the District Court properly granted Appellee’s motion to dismiss.