Medicare's first penalty against a pathology provider for paying above market rents

The Federal Court has imposed a $1.65 million penalty on a pathology company for paying rents on collection rooms within medical centres at “significantly above” market rates. This is the first penalty imposed on a pathology service provider for this type of conduct.  While significant, the penalty and contraventions reflect agreed terms, and so comprehensive deliberation on the key concepts, such as the methodology to determine ‘market value’ for the rent of such sites, was not undertaken.

The Health Insurance Act prohibits inducements being made by pathology service providers to referring doctors – including the payment of above market rents.  The public policy rationale is to prevent the over referral of pathology services for patients.  However, the central business importance of convenient pathology collection rooms (especially those located within medical centres), and the competition for such sites between pathology businesses, has made the issue of site rents a complex and central one in the sector.

Key Takeaways This recent decision demonstrates Medicare’s focus on incentives which may distort the way doctors refer patients for Medicare services, especially in respect of services such as pathology and radiology, which account for a significant portion of the funds expended by Medicare each year (estimated to collectively be in excess of 30% of Medicare’s total expenditure).  This focus is not new, but obtaining a finding of contravention is. As the findings were ultimately by consent, threshold sector issues such as the correct test for determining the ‘market value’ for pathology sites remain untested and several issues surrounding the scope of the relevant market and the identity of participants in this segment of the market, remain unresolved. Pathology service providers, and medical centres renting rooms to pathology providers, should review their policies (and practices) to ensure that any commercial relationships do not result in a benefit being passed from Medicare funded service providers to requesting doctors, and most relevantly, that the processes used to negotiate rents are carefully reflective of market prices. Commercial agents negotiating rents on behalf of both pathology service providers and medical landlords should be educated on this decision and the underlying legislation, to ensure the market processes relied upon to set the rental rate are appropriate and documented.

 

Background

 

As noted in a previous JWS insight,[1] in early 2021 the Chief Executive Medicare (Medicare) commenced proceedings against Specialist Diagnostic Services Pty Ltd (now known as Healius Pathology Pty Ltd) (SDS) alleging that SDS had contravened the Health Insurance Act 1973 (Cth) (Act) by entering into four leases and agreeing to pay rent that substantially exceeded the market rate for approved collection centres for pathology services (Approved Collection Centres).

After two and a half years of protracted litigation, SDS admitted to contravening the Act on four separate occasions (in relation to two sites).  On 18 August 2023, the Federal Court delivered judgment and imposed a $1.65 million penalty on SDS,[2] marking the first occasion on which a penalty has been imposed on a pathology service provider for providing benefits to requesters of pathology in the form of above market rents.

SDS, which trades under a number of business names including “Laverty Pathology”, is one of the three dominant participants in the pathology services industry in Australia.  It currently operates approximately 680 Approved Collection Centres in NSW, and during the financial years of FY2015 to FY2020 received nearly $5 billion from the Commonwealth in respect of pathology claims under the Medical Benefits Scheme.

The relevant leases

In February 2015, SDS entered into:

(a)a two-year lease for a 4.76m² pathology room located inside a dermatology medical centre in Castle Hill, NSW, for rent of $150,000 per annum (ex. GST) (2015 Castle Hill Lease); and

(b)a two-year lease for a 8.41m² pathology room located inside a dermatology medical centre in Kingswood, NSW, for rent of $200,000 per annum (ex. GST) (2015 Kingswood Lease).

In August 2017, SDS entered into new three-year leases for each of the Castle Hill and Kingswood pathology rooms.  The rent payable under these new leases was approximately $153,000 (ex. GST) and $204,000 (ex. GST) per annum, respectively (the 2017 Castle Hill Lease and the 2017 Kingswood Lease). 

The landlords of these medical centres in Castle Hill and Kingswood were companies, the directors of which were medical practitioners (Landlords).  The Landlords were therefore “requesters” of pathology services within the meaning of the Act.

Medicare’s Case

Medicare alleged that:

(a)by entering into each of the four leases and agreeing to pay rent pursuant to those leases, SDS provided benefits to the Landlords within the meaning of section 23DZZID(1) of the Act (Benefits); and

(b)none of the Benefits were a “permitted benefit” within the meaning of section 23DZZIF(1) of the Act, because the rent for each lease was substantially more than the market value of the rent.  Relevantly to this element of the case:

(i)the legislation provides that a lease will not be a permitted benefit (and therefore will be prohibited) if the rent is substantially different from market value: s 23DZZIF(5) of the Act; and

(ii)under the legislation and regulations “substantially different” means if the difference between the market value and the payment or consideration is more than 20% of the market value: s 23DZZIF(9) of the Act and Health Insurance Regulations 1975 (Cth), reg 20CA.

In support of these allegations, Medicare served expert evidence regarding the market values for each of the Castle Hill leases and the Kingswood leases.  Those expert opinions asserted that the market value for the Castle Hill property was $30,000 and $35,000 per annum on commencement of the 2015 and 2017 leases, respectively; and the market value for the Kingswood property was $75,000 and $82,500 per annum on commencement of the 2015 and 2017 leases, respectively.

Medicare’s expert evidence, if accepted in full by the Court, would have resulted in a finding that SDS paid up to 470% more than the market value of these properties.  An amount that is very significantly greater that the 20% differential provided for in the regulations, which is the maximum limit for any permitted benefit within section 23DZZIF(1) of the Act.

Relevantly, SDS did not accept Medicare’s expert valuation evidence.  Notwithstanding, SDS admitted that when it entered into each of the Castle Hill leases and the Kingswood leases the amount of the benefit to be paid to the Landlords was substantially different from the market value because the difference between the rental amount and the market value was significantly more than 20% of the market value.  Therefore, SDS admitted to contravening section 23DZZIL(1) of the Act on four occasions by entering into each respective lease.

Penalty

An agreement was reached between the parties, by which SDS agreed to pay a total pecuniary penalty of $1.65 million for its conduct, calculated as follows:

(a)$375,000 for each contravention arising from entering into the 2015 Castle Hill Lease and the 2015 Kingswood Lease; and

(b)$450,000 for each contravention arising from entering into the 2017 Castle Hill Lease and the 2017 Kingswood Lease.

In approving this penalty, which amounted to more than one third of the maximum penalty available, Justice Stewart recognised that the following factors justified such a significant penalty being imposed:

(a)SDS was familiar with its obligations under the Act, including the requirement that it only provide “permitted benefits” to requestors of pathology services, and previously gave an undertaking to the Minister for Health that it would comply with the Act and regulations;

(b)SDS’ conduct created a risk that the making of pathology requests, which are funded by the public health system, could be affected by commercial arrangements which could impact the quality of services provided to patients;

(c)SDS is a dominant participant in the pathology market in Australia that had the capability to assess the market value of these leases.  Despite this, SDS paid rental amounts that were substantially greater than market values;

(d)the difference between the rental amount and the market value for each lease was very significantly more than 20% of the market value; and

(e)SDS’ senior management were aware of and approved entry into each of the four relevant leases.

SDS was also ordered to pay $200,000 in Medicare’s legal costs.

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