Recently, a former Texas hospital (the “Hospital”) settled a multi-million dollar False Claims Act civil lawsuit involving the acquisition and use of funds from the largest Federal Housing Administration-backed mortgage for a for-profit hospital. The Hospital settled for $13.6 million and three top executives of the hospital, along with the development company, will collectively pay $1.8 million to resolve the false claims allegations for the development of the project. An additional settlement was reached with the Hospital for $1.1 million to resolve allegations of false claims submitted to Medicare and Medicaid programs.

The case involved civil False Claims Act allegations brought by the United States over the misuse of proceeds from a loan backed by the U.S. Department of Housing and Urban Development's (“HUD”) Federal Housing Administration (“FHA”). The National Housing Act (the “Act”) created a program to support investment in hospitals in underserved communities by offering to insure the loans necessary for the construction of hospitals in those communities. However, the Hospital allegedly made numerous false statements and material omissions during the application process in order to overstate physician support for the hospital and understate other key credit risks according to the Department of Justice. Physician investor support was one of the key factors driving the creditworthiness of the Hospital, but support had eroded by the time of closing when the Hospital fell $5 million short of the $38 million equity stake required to close the loan.

The lawsuit accused the Hospital, the development company and the executives of both companies of three key misrepresentations throughout the application process:

  1. The parties inflated the image of physician support in the Hospital and “declined to refund money to physician investors who had canceled their investment in the hospital.” The parties allegedly used $1.8 million of the funds that were supposed to be repaid to physician investors for the down payment on the loan.
  2. After the Hospital reportedly claimed to have 102 physician investors, the number dropped to 76 shortly before the scheduled closing of the loan. The Hospital quickly found non-physician investors to make up the difference without consulting HUD, which is prohibited under the Act. Without knowing that the investment group included non-physicians, HUD mistook investor support as a proxy for physician support.
  3. Executives signed side agreements to provide kickbacks to insider investors in order to secure additional funding. The Hospital secured $1.5 million in additional investments to close the transaction from board members in exchange for $900,000 in fees for “unspecified work to be performed” as well as early redemption for the notes.

The lawsuit alleged these three actions directly violated HUD's regulatory requirements and mislead HUD's decision to back the loan through the FHA. The Hospital was insolvent at the time of closing on the loan, but HUD was unaware of that fact and thereby proceeded to close and insure the loan.

The lawsuit alleged the fraud continued after the closing. The Hospital allegedly used funds from the loan to pay for federal lobbying even after HUD informed the Hospital that using the funds for lobbying purposes would violate the permitted uses of the federal loan. The funds were also used to repay investors who had backed out of the project.

The lawsuit accused the named defendants of violating the False Claims Act, and Financial Institutions Reform, Recovery, and Enforcement Act of 1989, as well as committing the common law tort of negligent misrepresentation. According to attorneys, claimed damages were valued at $368 million, but the settlement of just over $15.3 million was less than 4.2% of that amount.

Practical Takeaways

When pursuing a loan for a hospital or health care facility, borrowers need to diligently review the loan documents to make sure that the representations made to the lender are true and accurate at the time of closing, and for any subsequent time frame as required by the loan. Along the same lines, borrowers need to make sure that the lender is aware of the status of the transaction, the parties involved in the transaction, and the investment thesis for the transaction, at the time of closing.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.