Prescriptions and Proscriptions: Specific Considerations When Representing Purchasers of Medical Practices

An attorney representing the purchaser of a medical practice must take into account all of the usual issues presented with any business transaction, but that attorney also must understand and be sensitive to the nuances uniquely affecting the medical profession. As with any business transaction, counsel needs to ensure that the assets being purchased are viable, intact, and free of liens, but perhaps even more than other businesses the fragile goodwill that goes along with those assets needs to be protected and preserved. Despite paying full value for a practice, a purchaser may discover that patients are reluctant to consult with a medical practitioner with whom they are unfamiliar or uncomfortable, which means the purchaser’s first interactions with patients are very important. Moreover, insurance and regulatory considerations create issues unique to the medical profession. When undertaking the representation of a purchaser, it is incumbent upon counsel to become familiar with these issues.

Continuation of Staff and Caregivers; Restrictive Covenants

As with any relationship founded upon confidence and the perception of capabilities, patients of a purchased medical practice may be wary of doctors with whom they are unfamiliar. To assuage those concerns, it is best to create an environment that provides the appearance of ‘business as usual.’ This is primarily achieved by maintaining the existing doctors and staff—at least for a transitional period. Particularly for the physicians selling their practice, a purchaser may require a minimum fixed-term period of employment as a component of the purchase agreement, coupled with a necessary covenant not to compete.

New Jersey’s Supreme Court has specifically enforced restrictive covenants involving the medical profession where the scope is deemed reasonable, where no undue hardship is imposed upon the employee/physician, and where the covenant is not injurious to the public.1 Karlin was revisited more recently in Community Hospital Group v. More, 183 N.J. 36 (2005) and its companion case of Pierson v. Medical Health Centers, PA, 183 N.J. 65 (2005), wherein the Supreme Court declined to reject Karlin despite the adoption by the American Medical Association (AMA) of an ethical opinion declaring that the AMA “discourages any agreement between physicians which restricts the right of a physician to practice medicine for a specified period of time or in a specified area upon termination of an employment, partnership or a corporate agreement.”2

As part of the transaction, a purchaser likely will seek to ensure restrictive covenants are in place, not only for the selling physicians but for the employee doctors as well. A greater degree of caution should be considered in the drafting of covenants for the employees, as courts likely will scrutinize such provisions to a higher degree than for the selling physicians. Unlike the employee doctors, the selling physicians receive compensation for the value of the practice, including goodwill.3

While many in the medical profession view restrictive covenants as a danger that can cause an impediment to necessary medical care, others (inclusive of New Jersey courts) view them as necessary means of protecting the ‘initial investment’ made in younger doctors and in preserving the goodwill of the business.

More determined that, simply because an employee was a physician, one’s profession alone did not, per se, void a restrictive covenant. Courts within and without New Jersey have taken the approach that a reasonable restrictive covenant will be enforced in order to protect the legitimate interests of the employing practice. “Covenants restricting a professional, and particularly a physician, from competing with a former employer or associate are common and generally acceptable.”4 Interestingly, More enlarged the general protections afforded an employer beyond merely the solicitation of patients under a restrictive covenant. The More court also enforced a provision that sought to protect referral sources.

In seeking to protect the purchased goodwill of a medical practice, a purchaser’s counsel should carefully draft restrictive covenants, keeping in mind the above considerations for selling physicians and employee physicians. The covenants should serve to continue the ‘look and feel’ of the practice and preclude a departing doctor from setting up a competing practice that would potentially strip away the very essence of what was purchased.

Qualified Purchasers

New Jersey, through the Department of Law and Public Safety and the Board of Medical Examiners, has codified the AMA’s corporate practice of medicine doctrine (CPOM doctrine) requiring, in general, that the owners of a medical practice, whether directly or indirectly, be licensed to practice medicine.5 With the objective of addressing the inherent conflict of interest between a corporate entity’s obligation to earn and provide profits to its shareholders and the obligation of a doctor to address a patient’s need for medical treatment, New Jersey—along with most other states—has required that all entities owning (or purchasing) a medical practice must be licensed persons. There are certain circumstances where it is permissible for non-physician healthcare professionals to own a medical practice, but this must be evaluated on a case-by-case basis. Accordingly, as the attorney for the purchaser, it is imperative that counsel conduct due diligence to ensure that the purchasing individual or group is qualified to take ownership.

Medical Records and HIPAA

A selling medical practice must ensure that the buyer agrees to serve as the seller’s agent and accept the responsibility for the maintenance and retention of all patient medical records. Under the Federal Health Insurance and Portability and Accountability Act (HIPAA), a selling practice is permitted to share protected health information (PHI) with a purchaser because the purchaser will use the PHI for “health care operations.”6 Importantly, the sale of a medical practice must not include the sale of medical records, since the content of those files is deemed confidential and may not be reviewed by the purchasing physicians until the patient authorizes and consents to treatment by the purchasing entity.

The AMA, through its Ethical Opinion 7.04, has stated that the transfer of patient records to a purchaser is subject to the following:

(1) The physician (or the estate) must ensure that all medical records are transferred to another physician or entity who is held to the same standards of confidentiality and is lawfully permitted to act as custodian of the records.

(2) All active patients should be notified that the physician (or the estate) is transferring the practice to another physician or entity who will retain custody of their records and that at their written request, within a reasonable time as specified in the notice, the records (or copies) will be sent to another physician or entity of their choice.

Thus, as part of the process to transfer patient records, counsel should ensure that an appropriate notice, consent and release is drafted and provided to each patient of the selling practice.

Review of Leases

Often overlooked assets of a medical practice are its office and equipment leases. As part of an attorney’s due diligence obligations, he or she should carefully review each lease to ascertain its expiration and opportunities for renewal or extension, along with the lessee’s obligations upon expiration. Unless the transaction is a stock rather than asset purchase (and, even then there may be issues which can arise upon a change of control), counsel must carefully review each lease to determine if it may be assigned and whether the lessor’s consent is required prior to assigning the lease.

Just as patients often have a substantial degree of loyalty and connection to their treating physicians, many patients also have a similar connection to, and may even require, the convenience of a particular office. Accordingly, counsel should review any real estate leases of the selling practice to ensure that an adequate period of time remains or that an extension is obtained.

Managed Care and Third-Party Payor Agreements

Agreements with managed care networks are often beneficial, as they provide a consistent flow of patients and a reliable source of income. However, these agreements are generally considered ‘personal service’ contracts and are not automatically assignable to the purchaser of a medical practice. Unless the purchasing practitioner has already been designated as an approved provider with the seller’s managed care network, the patients and that component of the income attributable to those patients may not be available. Accordingly, the valuation of the practice may be inflated. Thus, it would be incumbent upon counsel to either work with the purchaser’s valuation consultant to ascertain the discounted value or, alternatively, to obtain authorization from the managed care network to become an approved provider.

Needless to say, the worst case scenario would be achieved if the purchaser were to pay full value for a medical practice only to have a core component of the practice fall away due to a termination of contracts with some or all of the seller’s managed care networks.

It is also imperative that, well before closing, all requisite reviews and approvals (known as credentialing) be completed by third-party payors—particularly if a relationship is being sought with a new provider. Although the process may vary for each provider, it is generally time consuming and cumbersome. A review of each physician by the provider can include gathering the doctor’s background information and comparing it against the National Practitioner Data Bank and the American Board of Medical Specialties; contacting any state in which the doctor is licensed; confirming completion of training and education with each institution; contacting the National Technical Information Service, Drug Enforcement Agency (DEA) and/ or Controlled Substance Registration to confirm the doctor’s authorization to write prescriptions; contacting Medicaid and Medicare to ensure the doctor is not banned from caring for patients under those programs; reviewing any malpractice history or claims; and confirming hospital privileges.

A substantial segment of a medical practice’s value may derive from its relationships with managed care and third-party payor providers. Accordingly, a diligent and organized approach to understanding the retention of those relationships is important and must be followed by the purchaser.

Malpractice Insurance

Obtaining and ensuring coverage for hazard, liability and worker’s compensation is essential in any business.

However, as an attorney representing a purchaser of a medical practice, counsel should confirm that sufficient malpractice insurance is in place not only for ongoing activities, but for prior acts. In conjunction, prudent counsel also will seek to have indemnification language drafted into the purchase agreement, holding the selling physicians liable for any potential unknown liability that may arise from acts occurring prior to the date of sale but that may result in the inclusion of the successor entity as a defendant in a lawsuit.

Although eventually overturned by the Michigan Supreme Court, the trial and appellate courts of that state, in Craig v. Oakwood Hosp.,7 certainly gave pause to the purchasers of medical practices when they held that malpractice liability would be visited upon successor ownership where it was found that: 1) there was continuation of the selling corporation’s business inclusive of the retention of key employees, operations and assets, 2) the selling entity ceased operations, 3) the purchaser assumed the liabilities necessary to continue uninterrupted operations, and 4) the purchasing entity held itself out as a continuation of the selling entity. In overturning the decision, Michigan’s Supreme Court held that the trial and appellate courts erred in finding that there was a de facto merger and continuation of business, since the share ownership changed and there was fresh consideration paid for the practice.8 Additionally, the court held that the usual rationale for disregarding traditional corporate law principles that disallow successor liability—namely to provide a remedy to injured plaintiffs—was not applicable because the plaintiff had viable claims against the treating doctors, so the successor owners were not the sole source of a remedy.9

Regardless of the final result, cases such as these are a signal to practitioners to take steps to limit a purchaser’s exposure to malpractice claims for acts occurring prior to the purchase. The necessary investigation by a purchaser or its counsel may commence with requesting the names and circumstances surrounding any patient who asked to have his or her files transferred or sent to an attorney for review. This necessary step may be layered by obtaining ‘tail’ insurance to cover any unfiled, potential claims, joined with demanding indemnification from the selling physicians as part of the purchase agreement. It is also important to note that a professional entity (whether a professional association or a limited liability company) does not protect a physician from personal liability with respect to professional malpractice.

Abandonment

Given that no review of a patient’s medical records may be conducted without prior consent, one concern of a purchaser of a medical practice should be ensuring that patients under the selling practice’s care are provided with continuous treatment. New Jersey recognizes a form of professional negligence known as abandonment. Abandonment is defined as the failure of a treating physician “to provide service to the patient when it is still needed in a case for which the physician has assumed responsibility and for which he has not been properly relieved.”10

In addition to the authorization requirement by HIPAA, providing notice serves to disclose and facilitate any transition in the providing of treatment. The notice advises the patient of the sale of the practice, the need for the patient’s continuous care, and that the purchaser will be available to treat the patient. Armed with this information, a patient is then able to effectively obtain treatment—hopefully with the successor entity.

Disposal of Controlled Substances

Upon the termination of the selling medical practice, it is incumbent upon the physicians to dispose of the practice’s inventory of medications in accordance with federal and state requirements. Counsel should advise the selling physicians to contact the special agent in charge at the local Drug Enforcement Agency (DEA) field office or the drug control unit for the authority and methodology to dispose of or destroy such substances. The completion of a form DDC-51 will be required, which itemizes the specific identity and quantity of the substances.

Counsel for sellers also should confirm that the selling physicians void all remaining prescription forms (DEA Form-222) and return the forms and the voided, unused scripts to the local DEA office.

Other Regulatory Concerns

The federal anti-kickback statute at 42 U.S.C. §1320a- (7)(b), and associated regulations at 42 C.F.R. §1001.952 (collectively, the anti-kickback rules) prohibit anyone from knowingly and intentionally offering, paying, or receiving remuneration in exchange for referring patients for goods or services covered by Medicaid or Medicare unless the transaction fits within discrete safe harbor exemptions (e.g., bona fide employment contracts or professional services contracts of no less than one year). Importantly, the anti-kickback rules may be invoked where the sale of a medical practice exceeds its fair value, giving the implication that the excessive payment is for patient referrals. A violation of the anti-kickback rules subjects the physician to criminal sanctions inclusive of up to five years in jail, preclusion from the Medicaid and Medicare program, as well as a fine of $25,000.11

Similarly, the self-referral or Stark law at 42 U.S.C. §1395nn and 42 C.F.R. 411.351, et. seq., generally prohibits physicians from referring a Medicaid or Medicare beneficiary for certain designated health services (e.g., physical therapy, radiology services, prosthetic suppliers and occupational therapy) to any entity in which a physician or member of a physician’s family has a financial interest. Once again, similar safe harbor exemptions exist, and practitioners should become familiar with them.

Although the payment of a purchase price for the acquisition of a medical practice would be considered a “financial relationship” under the Stark law, physician services are not one of the “designated health services,” and therefore do not fall within the purview of the Stark law.12 However, under the current economics of medical practices, sales of these practices may include operations or assets that may be ‘designated health services.’ Counsel involved in the acquisition and sale must be mindful of the ancillary businesses involved and protect against any violations, however unintentional such violations may be. In the event of a violation, a physician is subject to a fine of up to $100,000 and preclusion from the Medicare and Medicaid programs.13

Conclusion

The landmines awaiting an unknowing practitioner representing a client in the purchase and sale of a medical practice are numerous. Counsel should closely scrutinize the transaction as well as the ethical and regulatory obligations imposed upon the medical profession. Failure to do so could subject a client to far more than a financial loss.

Bruce E. Baldinger is the managing member of The Law Office of Bruce E. Baldinger, LLC, in Morristown. He is a 1984 graduate of the University of Miami Law School and focuses his practice on commercial and securities litigation. Gary Baumwoll of The Law Office of Gary Baumwoll, Esq., is an attorney in New Jersey and New York who has focused his practice on the legal issues surrounding the practice of dentistry since he began his law career. He specializes in dental practice transitions, partnership agreements, dental office leases, employment and independent contractor agreements and corporate formation. His wife Heather Baumwoll, D.M.D. is an orthodontist, which provides him with unique insight into the specific issues that face dentists.

Endnotes

1. Karlin v. Weinberg, 77 N.J. 408 (1978).

2. A.M.A. Council on Ethical & Judicial Affairs, Opinion 9.02 ( June 1997). The AMA did condition its opinion permitting some restrictive covenants where they were not excessive in scope or duration and where reasonable accommodations were made for a patient’s choice of physician.

3. This concept is evident by analogy to cases that have addressed sales of businesses outside the medical context. In Laidlaw, Inc. v. Student Transportation of America, Inc., 20 F. Supp. 2d 727, 754 (D.N.J. 1998), the district court stated that restrictive covenants “ancillary to the sale of a business ‘are accorded far more latitude’ than restrictive covenants to an employment agreement. Sound reasons support this different treatment.” See also Solari Industries v. Malady, 55 N.J. 571, 576 (1970).

4. Gelder Medical Group v. Webber, 41 N.Y. 680, 683, 363 N.E. 2d 573, 576 (1977).

5. N.J.A.C. 13:35-6.16(f).

6. “Health Care Operations” is defined under 45 C.F.R. §164.501(6)(iv) as “business management and general administrative operations of the entity, including, but not limited to the sale, transfer, merger or consolidation of all or part of the covered entity with another covered entity.“

7. 684 N.W.2d 296, 471 Mich. 67 (Mich. 2004).

8. Id. at 315.

9. Id.

10. Clark v. Wichman, 72 N.J. Super. 486, 492 (App. Div. 1962) (emphasis in original).

11. 42 U.S.C. §1320a-(7)(b)(a)(i).

12. 42 U.S.C. §1395nn(h)(6).

13. 42 U.S.C. §1395nn(g)(4).

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