Buying physician practices can mean buying trouble
December 1, 1997 7 minutes read
Buying physician practices can mean buying trouble
By Stuart R. Kaplan
Eckert Seamans Cherin & Mellott
Pittsburgh
Hospitals and other organizations have been busy buying private physician practices to "shore up" covered lives and for other strategic reasons. These acquisitions are sometimes successful for all involved, producing operating efficiencies, reducing costs, and enhancing community service. More frequently, however, the purchase of a physician practice presents significant operational and risk management challenges for the buyer.
Claims against the purchased practice and its physicians are likely to also name the buyer in search of deeper pockets to pick. Falling reimbursements, reduced productivity incentives and other factors make it more difficult than ever to operate a physician practice profitably, much less to cover the costs associated with the practice’s malpractice risks.
A careful approach to buying physician practices can help distance the buyer from the practice’s malpractice risk exposure, curtail the buyer’s exposure to operating losses, afford the selling physicians greater autonomy, and maintain significant incentives for physician productivity.
The new structure described here has its own legal and regulatory challenges and will not be appropriate in every instance. Nevertheless, this structure has been employed in several physician practice acquisitions to the satisfaction of buyers and sellers alike.
Some risks shifted to MDs
In a typical physician practice purchase, a hospital buys a practice’s assets or capital stock for an appraised sum and enters into employment contracts with each of the practice’s physicians. In acquiring the practice, the hospital also folds the practice and its physicians into the hospital’s risk management structure, introducing its risk management protocols and covering the cost of the practice’s malpractice insurance.
This traditional purchase model works well where the practice earns enough following the sale to repay the up-front investment, cover the guaranteed base salaries, and pay the costs associated with the practices’ malpractice risks. If earnings decline or exposure increases, however, the hospital may find that it has struck a bad deal.
To avoid having a purchase turn into a risk management disaster, buyers have begun structuring practice acquisitions in ways that shift some of the risks of post-closing operations to the physicians while preserving physicians’ autonomy. Here’s how one such revised structure works:
1. The practice’s assets or stock are acquired in the typical manner, but instead of entering into employment agreements with the selling physicians, the buyer enters into an independent contractor agreement with the physicians’ professional corporation and its physician employees.
2. The contractor agreement obligates the professional corporation and its physicians to continue to provide medical services to the professional corporation’s patients, plus any additional patients assigned by the purchasers, subject to the risk management oversight and guidance of the purchaser.
3. The independent contractor agreement provides for the lease of the purchased assets back to the professional corporation at fair market value. The professional corporation pays all of its operating expenses, including the salaries and malpractice insurance premiums of its physicians and other personnel.
4. To finance these costs, the professional corporation retains all of the revenues that derive from its services.
Physicians favor independence
Selling physicians often prefer this structure since it enables them to avoid becoming "employed" and allows them to retain the net revenues from their practice. They continue to operate their practice in the manner to which they are accustomed (subject to the buyer’s oversight) and continue to have an incentive to increase productivity and control risks.
Buyers like this arrangement because it protects them from operating losses and malpractice risks. Since the physicians continue to be employees of their practice not the hospital and the practice continues to be responsible for the risks associated with its services, this revised structure also helps to insulate the hospital from claims against the practice and its physicians. While a plaintiff suing a practice physician also may include the professional corporation and the hospital in the action, the independent contractor status of the practice diminishes the likelihood that a court will find the hospital liable.
This sale arrangement also discourages reductions in productivity, which often follow a sale, since the physicians continue to earn what they produce. To the extent that the purchase is nonetheless unprofitable, the purchaser is "out" only its initial investment in the practice’s hard assets, instead of also suffering the ongoing losses associated with the physicians’ guaranteed base salaries exceeding their revenue generation.
Some drawbacks for purchasing hospital
While this format has definite advantages, it does have these drawbacks:
• Though many physicians dread becoming employees and are reluctant to sell their practices, some realize that a guaranteed base salary for five to 10 years is preferable to retaining their practice’s income during the same period.
• If the practice is profitable following the purchase, the buyer will earn less from the practice’s post-closing operations than it would otherwise.
• It may be more difficult for the buyer to make desired changes in the administration and delivery of care.
• Because of the proposed model’s novelty, greater tax and legal analysis is required than would otherwise be the case.
It is difficult to anticipate how the Internal Revenue Service would react to this proposed sale structure. If the buyer is a nonprofit institution, private inurement and intermediate sanction concerns might arise from allowing the selling physicians to retain their revenues. Nonetheless, if the price paid for the assets is fair, one could argue that paying the physicians the net revenues of the practice is less likely to lead to abuse of the purchaser’s nonprofit status than paying "guaranteed" base salaries which frequently exceed the income guaranteed from the practice’s operation.
Be careful with documenting referrals
To avoid charges of fraud and abuse, the buyer should document that referrals are not being purchased with the up-front payment for the practice’s assets. This can be done through independent appraisals and analyses of competitive offers. The payment made by the practice for the lease-back of its assets also must be justified. Any other payments between the practice or the physicians and the buyer (e.g., for billing services) must be fair and covered by fraud and abuse safe harbors.
The Office of the Inspector General might nonetheless take the position that the proposed sale structure is impermissible since the physicians retain their revenues following the sale of their assets. It could be argued that this sale structure offers an incentive for the physicians to make patient referrals to the hospital buying that practice.
But it is not clear why giving the physicians their net revenues should be viewed as a greater incentive for referrals than paying the physicians significant guaranteed base salaries, as it typically done. The buyer also would have to make certain that neither the physicians nor their professional organization receive any considerations, either directly or indirectly, for referrals. Tax and legal consultants should be consulted with any transaction of this kind.
Consider software agreements
One aspect of physician practice acquisition that often is overlooked involves software license agreements. Hospitals and health care organizations should review carefully the software license agreements of a physician practice you intend to acquire. You also should examine your own software license agreements at the same time. At issue is whether the acquiring hospital or health care organization may use the physician practice’s software databases, other computer records with patient medical and billing information and, if applicable, software systems to incorporate the practice into your organization. Depending on what the software agreements say, you may be able to use them with no problem or you may have to obtain permission, if possible.
The acquiring organization is likely to follow one of these two post-acquisition software usage scenarios, or some combination of the two:
• The acquired physician practice will keep using its existing information systems, in which case it may be necessary to assign its software license agreements to the acquiring hospital or health care organization. New interfaces between the physician practice an the acquiring organization may be necessary to centralize record keeping.
• The physician practice will not use its existing software after the acquisition, instead transferring its records to the acquiring hospital or health care organization’s information systems.
Terms of the existing license agreements of the acquired physician practice or acquiring hospital or health care organizations could affect both of these options. Vendor-proposed license agreements may favor the vendor, but the terms generally are negotiable within reasonable bounds. These are some common red flags in standard vendor-proposed software license agreements:
• A successor to the licensee has no right to use the software, and the licensee cannot assign the license agreement to any successor or acquiring organization.
• The software is usable only at a specific location, which may not fit the needs of the post-acquisition organization.
• There is no option to add users, or there is a cap on the number of users that inhibits the effective use of the software by the post-acquisition organization.
• A long-term service contract is not cancelable and the post-acquisition organization must pay continuing support payments for software that it will not use.
• There are penalties for terminating the license or support agreement.
• There is no requirement that the vendor cooperate with other software vendors in the transition to another software system or to interface the existing system with software systems the post-acquisition organization uses.
Risk managers must remember that software license agreements can be a critical flaw in the acquisition if overlooked. Problems with the software licenses usually can be worked out during the acquisition, but failure to address them early might mean that the physician practice’s data are unavailable just as the acquiring organization needs it the most.
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