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Consignment Closets: Still a Viable Option for DME Providers

In the age of heightened regulatory scrutiny, physicians and other health care providers often question whether “Consignment Closet” relationships are legal.  If properly structured these arrangements are not only legal but are of great benefit to patients needing valuable medical devices.  A properly structured relationship will, in all probability, withstand a regulatory challenge by the Office of Inspector General or from other regulatory authorities.

Consignment Closets or “Stock and Bill” arrangements are used by many durable medical equipment, prosthetics and orthotics suppliers (“DMEPOS”).  The DMEPOS supplier places inventory in space rented from a physician’s office.  This allows the patient to immediately receive equipment or devices that they need as they leave the physician’s office.  The DMEPOS company, not the physician, bills the patient or the patient’s insurance carrier (or other third party payor) for the device.  In proper Consignment Closet models the patient should never be forced to obtain devices from the physician’s office and are free to use the supplier of his/her choice.  When a patient chooses to obtain the device at the physician’s office the physician’s staff will instruct the patient on the use of the device or “fit” a brace or other product provided.  The DMEPOS supplier will compensate the physician’s office for this service, as well as for administrative services provided by the physician’s office staff for providing billing information to the DMEPOS supplier.  The DMEPOS supplier also rents from the physician the space in the physician’s office where the DMEPOS supplier’s inventory is stored.

The relationship between the DMEPOS supplier and physician as described above can pass muster from a regulatory perspective as long as the arrangement complies with the Stark Law and the Federal Anti-Kickback Statute (“AKS”).

The Stark Law, in a nut shell, prohibits a physician from referring a Medicare or Medicaid patient for Designated Health Services (“DHS”) to an entity in which the physician or immediate family member of the physician has a financial relationship.   DMEPOS are considered DHS for purposes of the applicability of the Stark Law.  A financial relationship is one in which physician has an ownership or investment interest or a compensation arrangement.  Under current interpretations and application of the Stark Law, services provided by the physician to the DMEPOS supplier will constitute a financial relationship between the physician and the DMEPOS company.   This type of arrangement can fall into an exception to the Stark Law (the “personal services exception“) and be permissible if the following elements are incorporated into the arrangement:

  1. The arrangement is in writing and specifies the services covered by the arrangement.
  2. The term of the arrangement must be for at least one year.
  3. The arrangement needs to cover all of the services to be furnished by the physician to the entity.
  4. The aggregate services contracted for do not exceed those that are reasonable and necessary for the legitimate business purposes of the arrangement.
  5. The compensation paid must be set in advance and be of a fair market value for the services provided and is not conditioned upon the volume or value of any referrals or other business generated between the parties.

As for the rental of the space to store inventory, the prohibitions under Stark are excepted if the following conditions are met:

  1. There must be an agreement in writing for a period of at least one year.
  2. The compensation must be of a fair market value based on usual rental rates for comparable office spaces in the community.
  3. The transaction is commercially reasonable and furthers the legitimate business purposes of the parties.
  4. The arrangement does not violate the Anti-Kickback Statute.

From the perspective of the Stark law, a consignment closet arrangement containing the elements discussed above will likely pass the scrutiny of federal regulators.  It should be cautioned, however, that even a slight deviation from the structure mentioned above may result in civil and criminal penalties.

The Anti-Kickback Statute is a criminal statute that prohibits anyone to knowingly and willfully offer, pay, solicit or receive any payment, directly or indirectly, overtly or covertly, in cash or in kind in return for referring an individual to another person for furnishing or arranging for the furnishing of any item or service or the purchasing, leasing ordering or arranging of any good, facility, service or item that may be paid for by a Federal health care program.  The government implemented numerous “safe harbors” that exempts from scrutiny an arrangement which meets ALL of the specified standards.  With the consignment closet arrangement, two safe harbors come into play.  The first is called the “personal services safe harbor” and the requirements are similar to those of the Stark personal services exception.  This safe harbor permits payments by a DMEPOS supplier to a physician so long as the following six standards are met:

  1. The agreement is in writing and signed by the parties.
  2. The agreement specifies the services to be provided by the parties.
  3. If the agreement is intended to provide for service of the agent on a periodic, sporadic or part-time basis, rather than a full time basis, for the term of the agreement, the agreement must specify the schedule of such interval, the precise length and the exact charge for such intervals.
  4. The term of the agreement must be not less than one year.
  5. The aggregate compensation paid over the time of the agreement is set in advance, is consistent with fair market value in arms-length transactions and is not determined in a manner that takes into account the volume or value of any referrals or business generated between the parties for which payment may be made in whole or in part under Medicare or Medicaid.
  6. The services performed under the agreement do not involve the counseling or promotion of a business arrangement or other activity that violates any State or Federal law.

The other safe harbor is called the “space rental safe harbor.”  It quite similar to the personal services safe harbor in that it requires: 

  1. The agreement is in writing and signed by the parties.
  2. The agreement covers all of the premises rented by the parties for the term of the agreement and specifies the premises covered by the agreement.
  3. If the agreement is intended to provide the lessee with access to the premises for periodic intervals of time rather than on a full time basis for the term of the rental agreement, the rental agreement must specify exactly the schedule of such intervals, their precise length and the exact rent for such intervals.
  4. The term of the rental agreement is for not less than one year.
  5. The aggregate rental charge is set in advance, is consistent with fair market value in arms-length transactions and is not determined in a manner that takes into account the volume or value of any referrals or business generated between the parties for which payment may be made in whole or in part under Medicare or Medicaid.
  6. The aggregate space rented does not exceed that which is reasonably necessary to accomplish the commercially reasonable business purpose of the rental.

It should be noted that while a properly structured arrangement may currently withstand regulatory scrutiny, regulators are closely examining consignment closet arrangements.  In fact, in 2009 CMS issued a transmittal that essentially prohibited arrangements when a DMEPOS supplier maintains an inventory at the practice location that is not owned by the DMEPOS supplier, but by the physician.  This rule required the physician to take possession of the DMEPOS items who then would have had to bill for the equipment using their own supplier billing number.  In addition to placing additional administrative and regulatory burdens on the physician (e.g. becoming licensed as a DMEPOS provider), this arrangement may be deemed to be in violation of the Stark law.

Fortunately, CMS rescinded the transmittal and the rule described in the preceding paragraph is not in effect.  CMS was scheduled to reinstate the so-called “consignment closet rule” in March 2010, but as of this writing, the rule has not been reinstated.

Therefore, unless and until the consignment closet rule is reinstated, DMEPOS suppliers and physicians are free to set up consignment closet relationships. However, DMEPOS suppliers and physicians must pay close attention that the Stark exception and anti-kickback requirements are complied with in the strictest possible sense.

The content of this article for informational purposes only and should not be considered legal advice.  Each situation is different and it is recommended that you contact an experienced health care attorney to advise you on the subjects discussed in this article.  Health care laws and regulations are subject to rapid change and the information transmitted in this article may not be applicable in the future.