The Health Law Ticker

As private equity firms, health systems and entrepreneurs in the medical delivery space seek to gain a level of control over physician practices, many choose to operate under the “Friendly PC” model, especially as many states place restrictions on the corporate practice of medicine.  Under this model, the professional corporation employs the physicians and the non-clinical assets are owned by the health system or private equity firm or related management company, which also employs the non-clinical employees. That management company then has an agreement with the Friendly PC to manage the day-to-day business operations of the medical practice. The physician owners of the Friendly PC may become paid directors or officers of the Friendly PC, which they still own.

While day-to-day operations are left to the management company, physician owners of the Friendly PC need to consider their ongoing responsibilities to the professional corporations they own and direct. While benefits of having a sophisticated third party management company manage their medical practices are many, the physician owners, directors and officers of the professional corporation still need to meet their ongoing fiduciary obligations and continue to operate their professional corporation in compliance with the corporate formalities. 

To determine the control level of the management company over the business operations of the practice, the parties draft a Management Agreement. To restrict ownership and transfer of shares only to physicians approved by the management company, the physician shareholders often sign Share Transfer Restriction Agreements^[1]. These two agreements give the management company a level of control over the physicians in the Friendly PC. Done properly, this control is over only the non-clinical aspects of the practice.

The risk to the physician owners, officers and directors of Friendly PC practices are many. These may include risks to their respective medical licenses if they violate corporate practice of medicine rules. These also may include risk of criminal fines and penalties for failure to properly oversee management company activity resulting in alleged Friendly PC violations of state or federal law. These risks increase if the friendly physician owner is perceived to be a rubber stamp to actions of the management company or effectively an absentee owner of the professional corporation.

Meeting fiduciary obligations and maintaining corporate formalities are a key aspect of the protections afforded owners and officers under the applicable state’s Corporations Code. Failure to meet these obligations can result in personal liability to the physician directors and owners. The management company may provide contractual assurances to the physician owners, officers and directors of the aligned Friendly PC, through insurance coverage and indemnification. These assurances, however, cannot restore a physician’s medical license should the Medical Board determine that the physician is violating the corporate practice of medicine prohibition in that state. In addition, these assurances are unlikely to be adequate in the event of a federal law enforcement indictment should the management company engage in criminal billing fraud where the Friendly PC’s officers and directors breached their fiduciary oversight obligations.

A physician owner and director of a third-party managed medical practice should consider whether they have proper policies and procedures in place to avoid several worst case scenarios. These include:

• The management company declares bankruptcy and fails to pay physician employees of the Friendly PC. The unpaid physicians then turn to the physician owner and director for payment.
• The management company fails to pay rent for the medical office locations and the landlords then lock the doors of the physician offices, prohibiting entry, including entry to retrieve patient medical records.
• Disgruntled employed physicians complain to the Medical Board that they have never met or received any direction from the President of the Friendly PC who signed their employment agreement and allege that non-physician managers of the practice are influencing medical decision-making.
• The Secretary of State suspends the professional corporation that constitutes the Friendly PC due to failure to make required annual filings or pay corporate taxes.
• The management company engages in fraudulent billing of the professional services performed by the Friendly PC’s physicians and investigators determine that the physician directors of the Friendly PC failed to provide compliance oversight.

The physician shareholders, directors and officers of the Friendly PC must keep in mind that, despite assurances by the management company that all is well, it is their responsibility to run the professional corporation in compliance with all applicable laws and regulations. Physician owners, directors, and officers can reduce much of the risk inherent in the Friendly PC model by maintaining proper corporate formalities. These include:

• holding periodic board meetings where financial reports from the management company are provided and reviewed and key managers questioned;
• periodically engaging independent auditors to audit activities of the management company to ensure they are complying with regulatory requirements;
• requiring the management company to have a formal corporate compliance program that meets standards set by the Office of Inspector General, U.S. Department of Health and Human Services, and then requiring that the assigned compliance officer provide quarterly reports on audit and investigation findings to the board of directors;
• making sure that the president or other key officer of the Friendly PC is actively engaged in the hiring of physicians and other professionals employed by the Friendly PC as well as all peer review and quality assurance activities in which they are involved; and
• hiring two separate legal counsel, one for the Friendly PC and the other for the management company, and then having the Friendly PC counsel regularly advise the physician directors.

A properly functioning professional corporation can significantly reduce risk for the owners, directors and officers of the Friendly PC.

^{1] I recently wrote about California Senate Bill 642 that, if enacted, would have required that the ultimate direction and management of the medical practice be determined by the physician owners, shareholders and directors, and not by the hospital system or private equity firm that manages the medical practice. Subsequent to my article, that bill died in the Legislature.}