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.)
Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them
At some point during their career, many physicians will face the prospect of selling their medical practice. Whether the result of a voluntary decision (such as a well-earned retirement) or a less happy situation (such as illness), the sale of a medical practice needs to be structured and carried out so as to best realize the selling physician’s two main goals: maximum profit and minimum postsale liabilities. The following are mistakes to avoid and action steps to take to ensure that these twin goals are met.
Mistake 1 Agreeing on Price Before Consulting a Valuation Expert
An appraisal of the practice by a qualified valuation expert is critical in both getting a fair price for the practice and dispelling any unrealistic notions of what that price may be. Few people would ever consider selling their home without consulting an experienced real estate broker or appraiser to determine a reasonable listing price, yet sellers of professional practices often take a do-it-yourself approach to valuing their practices based on criteria that may have no applicability to a given situation. This approach often results in either selling the practice for considerably less than it’s worth or scaring away potential qualified buyers.
Action Step Before the practice is offered for sale, physicians should hire a professional valuation expert qualified to appraise medical practices in their specialty and geographical area.
Mistake 2 Agreeing on Terms and Conditions Before Consulting an Attorney
A typical scenario in the sale of a practice is two parties, neither represented by counsel, agreeing on the essential terms of the transaction. One party, usually the seller, then goes to an attorney to “draw up the documents” based on the agreed terms. Unfortunately, by that time it may be too late to implement any changes recommended by the attorney to better protect the seller, since the prospective buyer has, in his or her mind, already reached a binding agreement. The sale is then either scuttled or carried out against the advice of counsel; worse, the disappointed buyer may sue based on the parties’ “napkin” agreement.
Action Step Once the decision is made to market their practice, physicians should have a qualified business transactional attorney prepare a draft “seller-oriented” agreement, which can then serve as a starting point for sale negotiations.
Mistake 3 Making Representations and Warranties That Cannot Be Supported
Sometimes the buyer approaches the seller with a draft purchase agreement in hand, either before or after sale negotiations have begun. In this case, the draft agreement usually includes a laundry list of seller’s representations and warranties, everything from “no pending litigation proceedings” (a reasonable warranty) to “no unknown liabilities” (an impossible warranty). Selling physicians may skip over this “legalese” to focus on more interesting issues, such as payment amount and terms, only to have an unsupportable representation come back to haunt them in the form of a fraud or deceit claim.
Action Step Physicians should carefully scrutinize each requested representation and warranty and agree only to those that they know they can reasonably make.
Mistake 4 Failing to Require Certain Representations and Warranties From the Buyer
While buyers typically need to make fewer representations and warranties than sellers, certain ones are critical if the selling physician is to have some peace of mind after the practice changes hands. Key among these are warranties that the buyer is licensed to practice medicine in the state in question, is in good standing with that state’s medical board, and is not subject to any actual or threatened discipline. While representations and warranties may not ensure against the selling physician being named in a malpractice suit or an administrative action arising solely out of the buyer’s conduct, they will form the basis for additional remedies in the event they turn out to have been false when made.
Action Step Physician sellers should include in the terms of sale specific buyer’s representations and warranties regarding qualification to practice and absence of disciplinary action, along with a duty of indemnification from third-party suits or other proceedings.
Mistake 5 Not Reviewing the Assignability of Key Third-Party Contracts
It sometimes comes as a surprise to selling physicians when they discover, usually well into the sale process, that their office lease, or an equipment lease or service contract, is not freely assignable to a new owner of the practice. In most cases it is not difficult to obtain a new lease or contract from the third party, but where the deal was particularly attractive to the buyer because of a below-market, long-term office or equipment lease or service contract, a failure to discover limitations on assignability beforehand can result in delays, reduction of the sale price, cancellation of the sale, or other problems.
Action Step Physicians should review the assignability provisions of each third-party agreement that is to be assigned in the sale. When assignment is restricted and the third party refuses to give its consent, physicians should expressly exclude the lease or contract from the terms of the sale.
Mistake 6 Getting Inadequate Security for Seller Financing
Sometimes financing by the selling physician is required to reach a deal, usually because commercial financing is too expensive, but sometimes because a buyer is considered by commercial lenders to be a poor credit risk. Most selling physicians are savvy enough to review a prospective buyer’s credit history before extending financing, but often they either fail to secure the loan altogether or secure it by the transferred practice itself (a costly mistake if the practice fails to thrive in the hands of the new owner).
Action Step Physicians should insist on security that is unrelated to the practice (e.g., a lien on the buying physician’s residence or other real estate).
Mistake 7 Agreeing to an Unrestricted Noncompetition Clause
The enforceability of noncompetition clauses (essentially, terms that limit the right of the selling physician to continue practicing medicine after the sale) varies from state to state, but these clauses are generally valid if they are restricted in terms of duration (e.g., five years), location (e.g., no competition within the same county or within a 25-mile radius of the transferred practice), or both. It would be a costly mistake, however, to wait until an actual controversy arises sometime later and then rely on the courts to interpret and limit the scope of an overbroad noncompetition clause.
Action Step Physicians should be sure that the precise duration and geographical scope of a noncompetition clause (if one is agreed to at all) are spelled out in detail in the sale agreement.
Mistake 8 Not Providing for an Express Assumption of Liability by the Buyer
When the sale is structured as an “asset purchase” rather than a “stock purchase” (because the practice is unincorporated or for some other reason), it is critical to expressly provide that the buyer will assume the liabilities of the practice, prorated as of the closing date. Many physicians forget that what they are hoping to gain from the sale is not only profit, but also relief from ongoing financial obligations and other liabilities.
Action Step Physicians should include a detailed list of liabilities that the buying physician will assume and a duty of indemnification from those liabilities.
Mistake 9 Agreeing to Buyer-Controlled “Holdbacks” From the Purchase Price
Sometimes a seller will not meet a certain condition to closing before the projected closing date, and the buyer may attempt to “hold back” part of the purchase price, usually in some type of escrow arrangement, until the condition is satisfied. Another use of holdbacks is to add “teeth” to a noncompetition clause by providing that any breach by the seller will result in forfeiture of all or a certain portion of the holdback amount, which would otherwise be released to the seller upon expiration of the noncompetition period. When the use of a holdback cannot be avoided, it would be a major mistake to give the buyer unilateral control over disposition of the escrowed funds.
Action Step Physicians should ensure that any holdback arrangement provides for the joint consent of buyer and seller to any disposition of the funds, along with a dispute resolution procedure in the event the parties cannot agree.
Mistake 10 Not Including Termination Provisions in the Agreement
Sometimes, despite the best of intentions, a sale cannot be consummated by the projected closing date. It is certainly reasonable to extend the closing date upon mutual consent of the parties, but where the buyer is having trouble raising the necessary cash or financing, or either party finds it cannot meet some other preclosing obligation, it makes sense at some point to terminate the transaction and remarket the practice for sale. However, in the absence of clear termination provisions, the buyer might be able to hold up the sale indefinitely, or, where it is the seller who is having trouble closing, the buyer may seek to hold the seller to the agreement.
Action Step Physicians should specify a clear “drop dead” date by which the sale must close unless the parties otherwise consent in writing, with a provision for return of funds and documents and a release from further obligations under the agreement.
Many of the potential mistakes in the sale of a medical practice can be avoided through proper planning and documentation, proving that, in law as well as in medicine, an ounce of prevention is worth a pound of cure.
Helena G. Francus, Esq.
Peer reviewed by:
John D. Martin, Esq.
Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them