The 10 Biggest Legal Mistakes Physicians Make in Hospital-Physician Contracting

Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)

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Executive Summary

Contracts between physicians and hospitals take many forms to address many relationships. Examples include medical director agreements, professional services agreements, exclusive service agreements, building and equipment lease agreements, management service agreements, contract-based joint ventures, and myriad others. This section discusses 10 mistakes often made in hospital-physician contracting. All of these mistakes find their roots in two broad failures: the failure to have common expectations and therefore an ill-defined relationship, and the failure to appreciate the importance of legal compliance.

Many hospital-physician relationships are of common form and may fit well within pattern agreements, modified to fit the particular situation of the parties. A lease of an office is a good example. While it is vitally important to read, understand, and modify (where appropriate) any such form agreement, it is nonetheless common to have an appropriate pattern or form lease. On the other hand, many hospital-physician relationships are unique. In such cases, it is important not to let the written contract define the relationship, but rather to make sure the relationship the parties want to have is accurately described in the written agreement. Having good legal counsel can help the parties explore their desired relationship and commit it to an enforceable written agreement. The goal is to make sure the parties have a common understanding of their relationship and that the relationship is committed to writing.

The importance of legal compliance cannot be overstated. Many legal principles apply to hospital-physician contracts, but three sets of legal principles are most acute in medical contracting. First is the Medicare antikickback statute (42 U.S.C. §§132a(a), et seq.). This law makes it illegal to solicit, offer, or pay any form of remuneration (e.g., money, property, or services, or items of value) designed to gain influence over the referral of a patient whose care will be paid for by Medicare, Medicaid, or any other government payer program. Sanctions for violations can include criminal convictions (including sentences that impose imprisonment and fines), civil monetary fines, and exclusions from the Medicare program.

The second is the Ethics in Patient Referrals Act, more commonly known as the Stark law. The Stark law, named after Congressman Pete Stark, provides for civil penalties if a physician refers a Medicare patient to an entity with which that physician has a financial relationship for one of 11 designated health care services (e.g., lab, imaging, physical therapy, inpatient or outpatient hospital services), and no exception exists for that relationship.

Third are principles that apply when a physician contracts with a tax-exempt entity. Many hospitals are exempt from federal income taxation under Section 501(c)(3) of the Internal Revenue Code of 1986. Tax-exempt hospitals must operate for the community benefit, and nonexempt entities or individuals can benefit only incidentally. A contract between a tax-exempt hospital and a physician may benefit the physician, but if the physician is paid fair market value for health care services needed in the community, any such benefit likely is incidental to the tax-exempt hospital’s tax-exempt purpose. With the advent of the intermediate sanctions law in 1997, a physician who is in a position to exert influence over a tax-exempt hospital’s affairs can be subject to excise taxes if he or she and the hospital enter into an “excess benefit transaction.” This essentially means that if a physician who is in a position of influence with a tax-exempt hospital is paid more than fair market value for services or other items of value, without paying fair market value for such services or items, then the physician and hospital executives who approve the transaction can be subject to penalties in the form of excise taxes.

In the context of these basic principles, this section discusses the 10 biggest mistakes physicians make in hospital-physician contracting.

Mistake 1        Failing to Consult Legal Counsel Early

Understanding the goals, desires, special interests, and objectives of the parties is important early on in negotiations. Knowing how these objectives fit within the applicable legal parameters can save the parties from negotiating a contract not allowed by the relevant legal principles. In such circumstances, the parties may be prevented from contracting with one another even when their objectives are legitimate solely because they have created a bad paper record or have had discussions that could be interpreted as implying an improper or unlawful purpose. Dozens of legal models have been developed to address the legitimate objectives of hospitals and physicians. Experienced legal counsel with health care regulatory expertise will be able to assist physicians in selecting the right model for the right circumstance.

Action Step     Physicians should consult legal counsel experienced in hospital-physician relationships, from both a business and a health care regulatory perspective.

Mistake 2        Entering an Agreement for a Hidden Purpose

Although not frequent, entering into an agreement for a hidden purpose is the biggest mistake a hospital and physician can make. Hospitals sometimes think about entering an agreement in which services are described but never performed. A variation is to try to describe services that a physician would perform anyway and pay the physician for those services. The idea behind the agreement is to compensate the physician for his or her “loyalty” to the institution. In other words, the hospital might perceive some intangible benefit associated with a physician’s affiliation with the hospital and want to compensate the physician for that intangible benefit (e.g., ability to influence referrals of Medicare or other government payer program patients). Such “sham” agreements are plainly illegal. A physician and hospital can make no greater mistake. Such relationships violate the antikickback statute and numerous other laws. In U.S. v. Anderson [85 F. Supp. 2d 1047 (U.S. Dist. Ct. 1999), rev. & remanded, U.S. v. McClatchy, 217 F.3d 823 (Civ. Ct. 2000)], physicians and hospital administrators went to jail because of such relationships.

An area of potential abuse is medical director agreements in which a hospital hires a part-time medical director for a service and the hospital has no real expectation of the service being provided. The implication is that the agreement is entered into to obtain the physician’s referrals. It is unlawful to structure a relationship in which one purpose of the relationship is to gain reason or influence over the physician’s referral judgment. It is appropriate to pay for a physician’s services; it is illegal to pay for his or her referrals. Likewise, if a hospital has a legitimate need for services, it should pay for such services, rather than expecting them to be provided in exchange for referrals.

Action Step     A physician should never enter into a discussion with a hospital in which the intent of the relationship is to influence referrals. Physicians should consult legal counsel early. Many models exist to align the legitimate motives of a hospital and a physician (e.g., improve quality, efficiency, patient access) without being construed as illegal inducements to refer. Physicians should make sure their duties are specified in the agreement and keep a written record of the duties they perform to prevent a later challenge that the duties were just a sham.

Mistake 3        Failing to Understand Market Data

Physicians often leave it to the hospital to obtain relevant market data supporting their compensation to be paid under a contract. Such information is key in hospital-physician relationships because many of the antikickback statute safe harbors, Stark law exceptions, and presumptions under the intermediate sanctions law require any compensation paid by a hospital to be consistent with fair market value. Sometimes hospitals control the data and are negotiating from strength. Other times, hospitals will lack appropriate data or mistakenly use incomplete data and thereby negotiate from a position of ignorance. Survey data may or may not be available or relevant to a particular market and circumstance. As a result of any of these circumstances, the physician will not be able to negotiate the maximum compensation that might otherwise be permissible. To negotiate the maximum compensation, the physician needs to make sure he or she has access to relevant fair market value data and understands the data.

Action Step     Physicians should research the market. They should consult legal counsel or other consultants to determine the compensation being paid in the market, as well as consult their professional society for resources. Also, physicians should consult recruitment firms to tap into their knowledge base of relevant compensation levels. Isolated examples of what a colleague received elsewhere will not be persuasive, nor will it satisfy a regulator if the relationship is later questioned.

Mistake 4        Relying on Verbal Assurances

The legal compliance issues arising in health care are complex. Often, they may appear to be at odds with the short-term business goals of an institution. It is not uncommon to hear phrases such as: “Don’t pay attention to that; that’s in the contract to satisfy the lawyers,” or “I’ll make sure this doesn’t apply to you; upper management says it has to be in the contract, but don’t worry about it.” There are at least two very important reasons never to rely on such statements. First, it may make the contract illegal under the antikickback statute or the Stark law. Both statutes require most contracts to be in writing and do not allow for side deals. Second, the physician will likely not have a legal right to enforce any such oral statements. He or she may well be dealing with an honorable person who is making such statements believing them to be true. But management changes at hospitals, as do circumstances and the motivations of the parties involved. In addition, markets change, and a hospital’s strategic direction will likely change. The person the physician dealt with may be gone, and the next person in charge will likely have every legal right, and may in fact have the legal obligation, to enforce the contract as written.

Action Step     Physicians should read the contract carefully. They should not let anything stay in the contract if they do not have the full expectation of being bound by such provisions. Likewise, if the contract does not contain an agreed upon provision, they should make sure it is added before they sign it.

Mistake 5        Relying on the Way Other People Do It

Often, physicians are tempted to enter contractual relationships that may appear to violate one or more of the previously discussed legal principles. The physician might hear: “They are doing it this way at St. Mary’s. How are they doing it if it is illegal?” Once again, health care law is complex. The facts of other deals may be different. Many transactions held out as examples are in fact not structured correctly. Worse yet, some participants in those other deals may go to jail or face significant liability. Physicians should not be swayed by the actions of others.

Action Step     Physicians should make their own decisions about what is legal in consultation with their legal counsel. They should make sure their decisions are based on the applicable law at the time their contract is entered into and is based on an analysis of their facts. 

Mistake 6        Failing to Address Term, Termination, and Renegotiation in the Agreement

Generally, a physician will want to have a long-term agreement. The physician will make financial decisions, such as recruiting partners, based on the expectation of having a continuing contract. This would suggest asking for a longer term. Hospitals may be constrained in the term of agreement they offer because they have tax-exempt bond financing that limits the terms of contracts they can have with others who use their facilities. It is necessary to know these rules and to make sure the hospital is interpreting them correctly because the allowable term varies based on the compensation methodology under the contract. Also, physicians should make sure to begin contract renewal discussions early. In fact, they should consider putting a provision in the agreement requiring early renegotiations. In addition, they should consider further renegotiating a contract early to effectively extend its term. For example, in a three-year agreement, a physician should think about renegotiating a year early so that he or she is never in a position of having only one year left on an agreement. The downside to a longer term agreement may be that the physician is bound to a compensation formula that becomes out of date.

Action Step     Physicians should identify what the best term is for them. They should note the renewal date on the calendar and be proactive in initiating renewal discussions.

Mistake 7        Failing to Address Noncompetition Covenants

Hospitals often seek to impose covenants not to compete that apply during the term and for a period of years after the term. Physicians should not assume that such covenants will be unenforceable. Although noncompetition covenants are not favored in the law, they are enforceable in most states if they are ancillary to an otherwise legitimate relationship. As a general rule, noncompetition covenants must be reasonable in duration and scope (covered services and geographic area). It is obviously best to avoid such covenants altogether, but that is frequently not possible. One should certainly attempt to limit their application. Physicians should try to limit the covenant to the term of the agreement and then only as to certain core services. They should avoid broad “practice of medicine” covenants. The agreement should allow the physician to perform activities that do not harm the hospital (e.g., academic or consulting services). Physicians should also seek to limit any postcontract noncompetition covenant if the hospital terminates the contract or does not agree to renew the contract, or if the physician terminates the contract for cause. If the hospital does not want to extend a contract, then the physician should ask for the right not to be bound by the noncompetition covenant. This can be important leverage at the end of a contract term. The hospital will be more likely to renew the contract if it knows the physician can compete if it does not renew.

Action Step     Physicians should review noncompetition covenants closely. They should determine whether the hospital’s interest can be protected another way (e.g., nonsolicitation of patients) or by a narrowly defined covenant. Also, they should make sure the covenant does not apply if the hospital breaches the contract or if the hospital decides not to renew the contract.

Mistake 8        Failing to Analyze Different Compensation Methodologies

As a result of the increasing complexity of health care regulation, finding legally compliant compensation models can be difficult. Experienced legal counsel can help structure a model that is both compliant and makes business sense. What type of compensation structure will best protect the physician should also be considered. Depending on the circumstances, a physician may be better off with fixed compensation. It provides certainty and removes the risk of business cycles, collection risks, and practice build-up delays. Production compensation methodologies can reward the high producer, but can also put the physician at risk if the hospital’s business suffers for reasons outside the control of the physician. In either event, compensation needs to be structured to compensate the physician for what the physician personally does, not for what he or she refers. A basic tenant of the antikickback statute and the Stark law is that a hospital can pay a physician fair market value for the services the physician provides and not for any other business the physician generates. Recent clarifications to the Stark law make it clear that percentage of production compensation methodologies are appropriate in many circumstances, assuming they can also pass antikickback analysis. Percentage compensation can be useful to align the goals of the parties and still mitigate downside financial risk.

Action Step     Physicians should outline their goals and interests. Are those goals best achieved through a stable payment or are the long-term objectives of the relationship better met by rewarding physician’s personal production? Physicians should consider whether a combination of the two best meet the parties’ objectives. 

Mistake 9        Failing to Remember Who the Customers Are

Practicing medicine is first and foremost about the patient. In hospital-physician contracting, however, the physician may not have a direct patient care responsibility or may be in a situation in which he or she is primarily assisting another physician in delivering care. Pathology, radiology, anesthesiology, and, to a lesser extent, emergency medicine are examples in which the physician not only serves patients, but also provides an important consultant or ancillary role. In these cases, other physicians on staff are also the contracting physician’s customers. The hospital, seeking to keep surgeons happy, wants to have timely, services-oriented anesthesia, radiology, and pathology services available to its practitioners. It is therefore important for physicians when contracting to become a service provider to a hospital to make sure those whose care is dependent on their services feel that they provide prompt and high-quality services. The physicians should be proactive in identifying issues. They should not assume that their contract will be secure. They should also be proactive with the hospital and make sure that members of their group serve on every medical staff committee. This is a good way to keep informed, as well as to stay in the power structure of the hospital.

Action Step     Physicians should identify the important medical staff committees and make sure members of their group serve on these committees. Also, they should meet regularly with the hospital’s CEO.

Mistake 10      Not Paying Attention to Indemnification Provisions

Hospitals often present an agreement that contains boilerplate terms. Physicians should not blindly accept these agreements. An indemnification obligation may expand physicians’ liability for their acts or the acts of those they supervise. A liability assumed by way of an indemnification clause is generally deemed to be a “contractually assumed obligation” and therefore may not be covered by a physician’s professional liability insurance. Often, the correct balance is to provide only that each party is responsible for his or her own acts and agrees to obtain insurance for those acts. Other times, indemnification should not be mutual. A physician may be stepping into a complex set of hospital issues over which he or she has little control, but, as a physician, might be a likely target in any legal action. In such a case, it may be appropriate for the hospital to indemnify the physician but not to have reciprocal indemnification from the physician.

Action Step     Physicians should read any indemnification clauses carefully and evaluate fully in light of the entire nature of the relationship. They should not be viewed as boilerplate, but rather carefully tailored contractual provisions based on the circumstances at hand. Indemnification clauses should be reviewed with the physician’s insurer to be certain the physician is not accepting liability for which he or she will have no coverage. 

Conclusion

Good physician relations are essential to the efficient operation of a hospital. A well-planned and well-drafted contract can eliminate future misunderstandings and create a mutually beneficial relationship. One should not think of a contract as necessary boilerplate, but rather as a tool to help the parties define their goals and relationship. The goal should be not only to protect the parties in the event of a dispute, but also to avoid the potential for dispute by proactively identifying the essential nature of the relationship. 

Written by:

Patrick J. Miller, Esq.

Peer reviewed by:

Steven J. Hippler, Esq.,

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