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 Physicians, like any business owner, must consider many business, legal, tax, and financial issues and risks when forming and structuring their business operations. The structuring of a physician practice is like any other business enterprise in that it should involve meticulous planning to avoid unnecessarily increasing potential liability. Consultation with legal and financial advisers at an early stage is critical.
Mistake 1 Failing to Consult with Legal and Tax Professionals Physicians must realize that forming and structuring a medical practice exposes them to many legal, business, and financial risks. The practice will have relationships and agreements with patients, employees, suppliers, other partners or shareholders, and lessors, among others. These relationships and agreements all create potential risks for the practice and physicians, which must be planned for. Physicians should consult with counsel early in order to address these issues properly. Proper planning, structuring, and consideration of the issues will shield physicians from significant liability exposure. If a physician seeks counsel too late in the process, the physician and the practice will have forfeited the ability of counsel to provide the physician with guidance, checklists, proposals, strategies, and tactics that afford maximum protection for the physician and the practice.
Action Step Like any business enterprise, physicians should immediately consult with experienced counsel when forming and structuring a physician practice.
Mistake 2 Failing to Properly Consider Whether to Form an Entity and, If So, What Type The initial consideration a physician faces is whether to form a legal entity to conduct the medical practice and if so, what type of entity to form. The choices include partnerships, limited liability companies, and corporations (S corporations, C corporations, and professional corporations). Each has different legal characteristics, tax attributes, and asset protection features. The unique features of a corporation are its perpetual existence (i.e., the death of an individual does not terminate the existence of the corporation); and its ability to limit the liability of its officers, directors, and shareholders. Conversely, physicians who participate in sole proprietorships or in general partnerships have unlimited personal liability. The problem for physicians is that personal liability for malpractice cannot be limited by using a corporation. Although a corporation won’t shield a physician from claims by a patient the physician treats, it can be used to defend against the negligence of a physician partner. If the practice was structured as a general partnership, the physician is legally responsible for any injury caused by his or her partners. Moreover, a partner could bind the physician and the practice to other contractual obligations, which also might create liability exposure. Except for professional malpractice cases, when the source of the claim arises outside of the physician/patient relationship, the corporation can be an effective device to shield the physician from liability. Thus, with respect to the other injuries that occur at the practice location, employee-related issues, or issues with landlords, customers, or suppliers, the corporation will provide a useful shield against personal liability, thus protecting the physician’s personal asserts. A
ction Step Physicians should consult with professionals to determine the type of legal entity that best suits their medical practice and consider the legal, tax, and asset-protection characteristics of the structure.
Mistake 3 Failing to Watch Out for Personal Guaranties Anyone doing business with a corporation may require the principals of the practice to give a personal guaranty of a corporate obligation, which may arise in the context of leases or financial transactions. Thus, if the corporation fails to make its payments timely, the landlord or lender can then collect directly against the guarantor. In this manner, a personal guaranty eliminates the benefits of the corporation and limited liability. Like any business arrangement, personal guaranties can be negotiated, so consultation with counsel is important in order to minimize the personal exposure. Physicians should not execute legal documents until they have been thoroughly reviewed and negotiated.
Action Step Consult with counsel to aggressively negotiate all contracts and guaranties in order to minimize the personal exposure.
Mistake 4 Failing to Maintain Corporate Formalities and Piercing the Corporate Veil The protection and limited liability features of a corporation will be available only if the integrity of the corporation as a separate and distinct entity is respected. Plaintiffs will attempt to convince the court that the corporation and the principals are one and the same and thus the corporate entity should not be respected (pierce the corporate veil), and plaintiffs can seek personal judgments against the owners of the business, thus creating unlimited personal exposure. It is critical that the business be maintained so that it looks and acts the way a corporation should. Physicians should pay attention to the corporate formalities, such as adopting bylaws, maintaining corporate minute and stock books, conducting all business in the corporate name, and maintaining separate corporate bank accounts.
Action Step Physicians should continuously consult with their counsel and accountant to ensure that corporate formalities are maintained and that the corporation is properly capitalized. They should take all other actions necessary to ensure that the corporate entity is respected in order to ensure that the corporation cannot be pierced. Limited liability comes with a price.
Mistake 5 Failing to Protect Corporate Assets The practice also must consider protecting the assets of the corporation, which is in the front line of attack for litigation from any source. If the corporation is unsuccessful in defending a suit, all of its assets are subject to seizure. Thus, a logical asset protection strategy should be developed for the corporation as well as for the individual physician. Generally, the corporation, as an operating entity, should have limited assets and should not build up its net worth. Assets such as real estate and equipment should not be owned by the corporation. Such assets should be held by other entities and leased back to the corporation. Additionally, the corporation should never hold a significant cash surplus. Such surpluses should be loaned or paid out as a salary or another type of distribution to physicians. Assets such as accounts receivable can be protected against outside creditors of the corporation by creating liens that will have a priority over subsequent creditors. This strategy can be accomplished by having the principals of the professional practice make loans to the corporation for working capital needs and as security for these advances; the corporation can then give the owners, as collateral, a lien in the receivables. A subsequent judgment creditor would find that the equity in these assets is subject to the superior claims of the owners.
Action Step Physicians should consult with counsel to create a structure that also protects the corporate assets. Creative thinking can provide significant protection and frustrate creditors.
Mistake 6 Failing to Use Multiple Corporations If the practice or corporation can be divided into separate businesses, assets can be further protected through the use of multiple entities. For example, a single corporation may own and operate five medical clinics in different locations. If something happens at one of these clinics, giving rise to liability or business failure, the assets of the other successful clinics must be isolated from these claims. A logical approach would be for each office location to be separately incorporated; thus if one location falters, it would not have an effect on the others. A judgment creditor of one corporation would not be able to reach the assets of the other successful companies.
Action Step As the practice grows, physicians should consider using multiple corporations for each practice location or distinct business endeavor. Physicians should consult with advisers to develop a proper plan.
Mistake 7 Failing to Protect Personal Assets Even with the shield of a corporation or multiple corporations, a physician still has potential exposure to professional malpractice claims or the execution of personal guaranties. Also, a physician faces exposure for events outside of the professional practice. If a physician cannot legally be shielded from personal liability, the proper strategy is to protect what the physician owns from potential claims. Several techniques and strategies (such as family limited partnerships, domestic trusts, and off-shore trusts) can be implemented to accomplish this goal, but planning prior to creditor problems is critical.
Action Step Physicians should consult with advisers to develop a structure and incorporate strategies to protect their personal assets from potential claims. Planning before creditor problems exist is critical.
Mistake 8 Failing to Plan for Life’s Curve Ball It is important to remember that unplanned events may occur in one’s life. A physician’s practice can obviously be dramatically affected by a disability or the death of a physician. Planning for “life’s curve balls” is critical. Working with financial, tax, and legal advisers and putting a plan into effect that incorporates appropriate insurance and legal documents (such as wills and buy-sell agreements) should be accomplished at an early stage. Moreover, a crisis team (which often includes a lawyer, an accountant, a spouse, and key office personnel) should be organized before a crisis occurs. Then, if and when a crisis does occur, the team can respond quickly to patients, lenders, lessors, suppliers, and others to ensure a smooth transition and to maximize the value of the going concern.
Action Step Physicians should consult with advisers to create a plan and have the appropriate insurance and legal documents in place in the event of a life curve ball. A crisis team should be formed prior to a crisis with a documented plan to respond if and when a crisis occurs.
Mistake 9 Failing to Properly Document Relationships with Other Physicians, Key Managers, and Partners When structuring a new physician practice, it is important to document the structure with written agreements and the rights and obligations of the respective parties. Employment agreements with physicians and other key members should be created, spelling out the compensation arrangements and other critical issues (e.g., such as termination rights, severance arrangements, and noncompetition and confidentiality provisions). If the practice includes multiple owners, a shareholder’s agreement should be prepared documenting the rights and obligations of the owners and the corporation. Any other critical relationships also should be documented properly. Working with competent counsel who can assist in identifying the relationships and agreements that should be documented and then properly documenting those arrangements are critical. Having these agreements in place at the beginning, when relationships are less contentious, allows the practice and its physicians to understand clearly their respective rights and obligations and will ultimately protect the practice.
Action Step Physicians should consult with counsel to ensure appropriate documentation of relationships and agreements.
Mistake 10 Failing to Develop Personnel Policies That Work Physician practices, like any employment setting, are potentially subject to employment-related litigation. Prevention is the key to minimizing this legal exposure. Policies and procedures should be created, documented, and reviewed. Key policies should be placed into an employee manual that is prepared by legal counsel in order to ensure that critical issues and disclaimers are included. For instance, the policy manual should state that the practice may, at any time, with or without cause, terminate the employment of the employee and that the practice maintains a strict policy of nondiscrimination. Typically, the employee manual also deals with issues relating to sexual harassment policies, compliance with confidentiality provisions, policies relating to technology and use of the Internet, job descriptions, job requirements, and expectations. By structuring clear employment policies at the outset and communicating these policies to employees, the practice may be able to avoid significant employment-related litigation.
Action Step Physicians should consult counsel to create well-documented employment-related policies.
Conclusion Physicians who are in practice or who are about to start a practice should be cognizant of these mistakes and take steps to provide the highest level of protection. Consultation with counsel at an early stage is critical.
Written by: Philip A. Goldblum, Esq.
Peer reviewed by: Scott M. Hare, Esq.