Deciding whether to sell a medical practice to an integrated delivery system (IDS), including management service organizations (MSOs) or physician-hospital organizations (PHOs), is a complex undertaking. Three considerations are of particular importance to physicians: net income over the next 10 or more years; control; and flexibility to pursue other avenues if the IDS is unsuccessful.

Before joining an IDS, physicians should ask themselves if they really need the hospital’s money in order to achieve their practice goals, and if so, how much. They should also consider if the hospital is the best source of funds, and if they will end up repaying some or all of the money to the hospital for management fees or other charges. Finally, they should determine what controls or other concessions the hospital might demand for its money.

To protect their interests, physicians should retain their own independent legal and financial advisors to help guide them through the complex process of joining an IDS. Key questions appear below.

Who is the buyer?

Because of the prohibitions against the corporate practice of medicine, private inurement and kickbacks, the identity of the purchaser can have a significant impact upon the terms of the purchase. The most common form of transaction is for a lay entity to buy the tangible assets of a physician’s or medical group’s practice. In almost all cases, a professional corporation owned by at least one California physician offers the physician, or physician members of a medical group, an individual employment agreement. Physicians may or may not be offered shareholder status within the professional corporation.

What is being purchased?

Is the physician selling his or her practice assets (such as furniture, fixtures and equipment) or stock (assuming the physician is professionally incorporated)? Note that a PHO, MSO or “foundation” cannot purchase the stock of a professional medical corporation; the stock can only be sold to another professional medical entity. Purchasers generally prefer to buy assets rather than stock in order to avoid assuming the selling physician’s liabilities. Whether the physician’s accounts receivable will be purchased can be a tricky issue because of the difficulty of valuing the receivables. In some cases, the receivables are not purchased; in others, physicians are required to turn over their receivables in order to help finance the start-up costs of the IDS. Finally, will the physician be paid anything for goodwill?

What is the purchase price?

Physicians are often lured to join an IDS by the prospect of receiving a “premium” price for their practices. While this may be possible in some cases, hospitals may have inurement problems (if they are tax-exempt), as well as fraud and abuse concerns that will prevent them from paying more than fair market value for a physician’s practice.

The price of a medical practice is usually a combination of the value of the tangible assets, accounts receivable (if sold), and the practice’s goodwill. Tangible assets can be valued at their original cost (such as for medical supplies), at “book” or depreciated value, or at fair market or replacement value.

Determining goodwill is much more difficult. Goodwill refers to the “going concern” value of a medical practice. This generally means the ability of the selling physician to transfer to the purchaser the practice’s reputation, patients and earnings stream. Among the methods used to determine goodwill are discounted percentage of net cash flow, capitalization of the practice’s net earnings in excess of those of the “average” physician in that specialty and geographic area, and market comparables, if any are available.

What are the terms of the management services agreement?

In most IDS arrangements, physicians enter into a long-term management services agreement (MSA) with their new hospital partner. The terms of the MSA can be more important than the terms of the practice sale. Among the key issues physicians need to consider are what services will be provided pursuant to the MSA; how much physicians will be charged for these services; and whether physicians will retain control (as they should) over all clinical matters.

Physicians should also retain ultimate control over the selection and retention of the chief executive officer of the IDS. Other key issues include how long the MSA is in force and under what circumstances it can be terminated. Finally, physicians need to have the ability to terminate the MSA if the relationship proves unsatisfactory.

Does the MSA violate the corporate bar?

When physicians consider entering into an MSA with a hospital, they should be aware that the Medical Board of California has expressed concern that such an arrangement has potential to violate California’s bar on the corporate practice of medicine (see sidebar). According to the medical board, the following business or management decisions and activities, resulting in control over the physician’s practice of medicine, should be made by a licensed California physician and not by an unlicensed person or entity:

• Control of a patient’s medical records, including determining the contents.

• Selection, hiring/firing (as it relates to clinical competency or proficiency) of physicians, allied health staff and medical assistants.

• Setting the parameters under which the physician will enter into contractual relationships with third-party payors.

• Decisions regarding coding and billing procedures for patient care services.

• Approving of the selection of medical equipment and medical supplies for the medical practice.

While a physician may consult with unlicensed entities in making the decisions described above, the physician must retain the ultimate responsibility for the approval of those decisions. The medical board cautions against “non-physicians owning or operating a business that offers patient evaluation, diagnosis, care and/or treatment” or “management service organizations arranging for, advertising, or providing medical services rather than only providing administrative staff and services for a physician’s medical practice.”[1]

THE SIDEBAR ON THE CORPORATE PRACTICE OF MEDICINE

What is the bar on the corporate practice of medicine?

The bar on the corporate practice of medicine prohibits lay individuals, organizations and corporations from hiring or employing physicians, or from otherwise interfering with a physician’s practice of medicine. The bar also prohibits lay entities from engaging in the business of providing health care services by contracting with health care professionals to provide those services. The corporate practice bar does not apply to physician partnerships or professional medical corporations because they are controlled by physicians.

Can hospitals employ physicians?

The California Attorney General has concluded that hospitals may not employ physicians to provide professional services. For example, to the extent a pathologist practices medicine (i.e., prescribes or diagnoses) as a hospital laboratory director, the nonprofessional corporate laboratory that employs the pathologist is unlawfully engaged in the practice of medicine.

To prevent violating the bar, doctors who work in hospitals form physician groups that enter into contracting agreements with hospitals. The medical group is responsible for paying the physicians’ salaries, not the hospital. Conversely, the medical staff at the hospital is responsible for granting practice privileges and for oversight of physicians.

Physicians can enter into contracts to provide services at a hospital, but the ability of physicians to share revenue with a hospital is also limited. Revenue sharing can only be done as long as a physician’s independent contract with a hospital does not impair the physician’s freedom of action, and the compensation received by the hospital is commensurate with its expenses incurred in connection with furnishing the facilities and services rendered. If the payments to the hospital exceed the actual value of services rendered, such overpayments would be considered fee splitting and are illegal.

Are there exceptions to the corporate bar?

Yes. Under limited circumstances, certain types of hospitals may directly employ a physician, including:

Teaching hospitals. A clinic operated primarily for the purpose of medical education by a private or public nonprofit university medical school can charge for professional services for “teaching patients” rendered by physicians who hold academic appointments on the faculty. As long as the facility is used primarily for the purpose of medical education and the services are for “teaching patients,” employment is authorized.

Hospital districts. The California Legislature created an exemption for hospital districts to employ physicians under extremely narrow circumstances.

County hospitals. The laws prohibiting the corporate practice of medicine do not apply to counties, given the broad “police powers” granted to them by the state. Thus, counties may employ physicians.

Are there other ways to legally circumvent the corporate bar?

No. Lay entities have attempted to circumvent the corporate bar by engaging physicians in various types of business arrangements, but these strategies are illegal. For example, a lay entity/hospital might agree to handle all business decisions and employ a physician to handle all clinical decisions. However, it is difficult if not impossible to isolate business decisions from those affecting the quality of care delivered to patients. The purchase of a piece of radiological equipment, for instance, could be looked at as a purely business consideration, or as a medical decision, or as an amalgam of both.

In addition to prohibiting lay entities from taking outright control over traditional medical decisions, California law prohibits most lay entities from:

• Having an economic interest in the net profits of a medical practice and/or

• Contracting with physicians on an employment or independent contract basis for the provision of medical services.

If a lay entity has a financial interest in a physician’s “bottom line,” then the entity has a direct interest in and ability to control the medical side of the business, such as how many hours the physician will work, what medications the physician may purchase, and what type of medical technology should be utilized. This is illegal.

Extreme caution should be taken if a hospital is trying to integrate medical practices through a “friendly” physician who has a majority stock in a medical corporation. An affiliated professional corporation can be used by hospitals to circumvent the bar. The courts and the Attorney General office can and do find such arrangements in violation of the bar where it appears that the lay entity is controlling the practice of medicine.

For more information, see CMA medical-legal document #0280, “Corporate Practice of Medicine Bar,” available at cmanet.org.

California law authorizes certain medical clinics, generally referred to as 1206(l) foundations, to operate without a license. To qualify, the foundations must conduct medical research and health education. They must also contain 40 or more physicians and surgeons who are independent contractors, representing not less than 10 board-certified specialties, at least two-thirds of whom must practice full-time at the clinic. Finally, they must be exempt from taxation in accordance with 501(c)(3) of the Internal Revenue Code. To be tax-exempt, a 1206(l) foundation must:

• Accept, as participating providers, all Medicare and Medi-Cal patients, without discrimination.

• Accept all indigent patients needing urgent care, potentially including necessary follow-up care to hospitalized indigents at free or discounted rates, depending on the patient’s financial status.

• Negotiate to participate in Medi-Cal and Medicare contracts, including Medi-Cal managed care contracts.

• Conduct “significant” programs of medical research and health education.

• Ensure that its hospitals maintain an open medical staff but not require physicians who contract with it to refer to its hospitals.

Working on the theory that the law exempts 1206(l) foundations not only from licensure, but also from the corporate practice of medicine bar, hospitals and health systems have sought to create foundations by purchasing all of a large physician group’s practice assets, obtaining tax-exempt status from the IRS, and then contracting with the former physician owners to provide medical care to what are now the foundation’s patients.

What other questions pertain to medical foundations?

Physicians who are considering selling their practice to a medical foundation should consider many other questions, including:

• How much control of the new foundation will the physician have?

• Is the medical group physician (or physicians) joining a multiple physician shareholder medical group or a single physician shareholder medical group (i.e., a professional corporation essentially controlled by the lay entity)?

• Will the medical group’s physicians be shareholders?

• What will be the term of the physician’s employment agreement with the foundation-affiliated medical group?

• How will non-physician directors be selected?

• How long does the contract between the foundation and the medical group run?

• How much will the medical group be compensated and for how long?

• Will the hospital have an unfair advantage in contract negotiations and the split of income from capitation and other contracts?

• Will the compensation arrangement be adequate to cover the charity care, research and education obligations that the medical group is being asked to assume?

• How much say will the group have in utilization and quality improvement standards and protocols, the adoption of practice parameters, the development of drug formularies, or the purchase of new technologies?

• Will the foundation or the medical group have the last word on credentialing, medical practice policies, and hiring and firing of the group’s own physician members?

• What will happen to the physician group’s current compensation policies regarding individual group members?

References

1. Medical Board of California, “Corporate Practice of Medicine,” www.mbc.ca.gov/licensee/corporate_practice.html (2011).

This article is adapted from CMA medical-legal library document #0218, “Legal and Practical Considerations Concerning Medical Foundations,” available at www.cmanet.org. For additional information, contact Samantha Pellon at spellon@cmanet.org or 916-551-2872.