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
Selling a practice or other business is one of the most important decisions a physician will make. All too often, however, the excitement of closing the deal results in not paying enough attention to the important details of the transaction. Just as good fences make good neighbors, good legal documentation minimizes the likelihood of postclosing disputes between the parties. While this section focuses on selling a medical practice, the fundamentals are equally applicable to the sale of any business.
Mistake 1 Failing to Learn Enough About the Individual or Entity Making the Acquisition
More often than not, simple inquiries before the sale can prevent considerable problems later. For example, the physician should request personal financial statements, credit reports, and references to verify that the prospective purchaser has the resources to consummate the transaction. Efforts should be made to determine if the purchaser has acquired other practices or businesses and, if so, the physician should contact the sellers to determine if the purchaser has satisfied all obligations. The physician’s attorney should search the court docket to determine whether any lawsuit is pending against the purchaser and, if so, evaluate the nature of the proceeding to determine if it has any bearing on the purchaser’s business acumen or honesty.
Action Step A physician who fails to learn about the purchaser may be entering into an agreement with an entity that has neither the willingness nor the ability to honor the agreement.
Mistake 2 Failing to Carefully Consider All Ramifications Resulting From the Structure of the Transaction
All acquisitions will be of either the stock or the assets of the entity being acquired. Behind that facile statement are a myriad of issues that must be carefully evaluated by the physician’s attorney and accountant, including tax effects, an indemnification agreement concerning postclosing claims, assignments of leases for property or equipment, employee obligations (including employee benefit plans), among others. The failure to have experienced counsel structure the best transaction possible may have long-lasting adverse consequences.
Action Plan The physician must review thoroughly with counsel how a proposed sale should be structured to maximize financial benefit while minimizing adverse tax consequences and liabilities.
Mistake 3 Failing to Ensure Adequate Security for the Purchase Price
If any part of the purchase price is to be paid postclosing, care must be taken to provide adequate security for the physician. In the medical practice setting, security options may include personal guarantees, an interest in the accounts receivable of the practice, or both. In the nonmedical practice setting, this might entail obtaining security interests in the assets transferred.
Action Step The physician must always remember that circumstances change. The most financially secure buyer, with the best business plan, may for a variety of factors be in a dramatically different financial situation in a short period of time. The failure to ensure proper security for postclosing payment obligations could result in severe financial loss.
Mistake 4 Agreeing to an Overly Broad Noncompete Provision
When enforceable under state law, a buyer is likely to request a noncompete provision in the agreement. This request may not seem particularly consequential at the time of sale, but unforeseen opportunities may arise after the sale that will require careful interpretation of any such provision. The duration and scope of any noncompete agreement must be carefully scrutinized, and the selling physician should attempt to limit the agreement as much as possible. This is particularly critical where the physician has been engaged to provide further medical or other services by the purchaser. If that relationship sours, and the physician has not intended to retire, a covenant not to compete can prove extremely troublesome.
Action Step The physician should carefully review the scope and duration of any noncompete agreement, particularly if the physician does not intend to stop working after the sale of the practice or business.
Mistake 5 Not Carefully Discussing and Negotiating Post-Transaction Employment or Consulting Obligations
Often, a hospital will acquire a physician practice and employ the physician to provide medical or business consulting services. The same types of relationships might be structured in other commercial, non-health-care settings. These ongoing obligations may present real problems if they are not carefully negotiated at the time of sale. For example, what will patients or customers be told about the new relationship, and by whom? What will be the terms and conditions of employment (e.g., call coverage for the physician)? Who will comprise the support staff and who will have authority over the staff?
Action Step The physician should not wait and trust that postclosing employment or consulting obligations will develop naturally. The parties may, in fact, have very different expectations, and the only way to prevent future disagreements is to address these issues before the sale.
Mistake 6 Failing to Consider How Postclosing Payments Will Be Calculated
Often, part of the consideration paid for the purchase will be a percentage of future profits of the business. Similarly, in the physician setting, a purchasing hospital may employ the physician and establish a bonus formula that will depend partly on collections. In either setting, efforts should be made to have such payments calculated based on gross, not net, collections. Manipulating net collections is a game mastered by some accountants. If forced to agree to payments based on net, the physician should negotiate exactly what will be included in deductions from gross. Physicians might understandably apply their own experience in billing and collection to extrapolate what they expect to collect as a hospital employee. All too often, these expectations will vary wildly from reality. The physician must carefully explore who will be performing billing and collection functions after the practice is sold and ask some hard questions during the negotiation process. For example, what is the historical collection percentage of the acquiring hospital? Which specific hospital employee or employees will be responsible for billing and collection of the physician’s practice efforts, and how much experience do these individuals have? If at all possible, the agreement should guarantee a minimum collection percentage.
Action Step The closing documents must specify how postpayment obligations will be calculated, leaving as little room as possible for uncertainty in this respect. A failure to properly consider this issue may lead to actual payments far below the selling physician’s expectations.
Mistake 7 Failing to Define Events of Default
In any case, where there are any postclosing obligations, the agreement must define under what circumstances the purchaser will be held to be in “default” of such obligations. For example, if the purchaser must make a certain payment by an agreed upon date, will the failure to make payment by that date be an automatic default or should a grace period be agreed upon? If the purchaser agrees to assume responsibility for certain obligations and fails to do so, the consequences of that failure must be addressed.
Action Step The physician and his or her counsel must review any postclosing obligations and consider the potential consequences of the purchaser’s failure to honor such obligations. The agreement must be tailored to define events of default and the consequences that will flow from the default.
Mistake 8 Failing to Carefully Delineate Dispute Resolution Provisions
It is common for a practice acquisition agreement to specify that disputes will be resolved by arbitration. If so, the provision must be reviewed carefully. All too often, arbitration provisions provide for extended discovery or extended time periods to resolve any dispute. Such provisions can significantly increase the time and expense of an arbitration proceeding. Further, the agreement should specify a mechanism to govern disputes that relate to billing and collection matters during the course of the relationship. It is very common for physicians and hospitals to disagree regarding amounts billed or collected, and a mechanism should be agreed upon (e.g., a review of the relevant documentation by an independent accounting firm) that would provide a method of resolving such disputes without litigation or a full-blown arbitration proceeding.
Action Step One goal of negotiation should be to provide an efficient and relatively inexpensive method of resolving disputes.
Mistake 9 Not Spending Enough Time Determining How the Relationship May Be Terminated
The decision to sell a medical practice is, obviously, a career-altering step. Once sold, many established relationships will be affected and new ones created. A physician who is employed by the purchaser must be careful to spend considerable time in negotiating and understanding how the new relationship might be severed. A “for cause” provision, specifying that the physician cannot be terminated unless there is some “good cause” is obviously preferable, but care must be given to defining what will constitute “good cause.” Conversely, what “causes” might a physician use to terminate the relationship? Routinely, hospitals will also insist on a “no cause” provision, typically in addition to the provision that would afford cause to terminate. For example, after specifying the “causes” pursuant to which the agreement may be terminated, the agreement might then specify that it may, in any event, be terminated for no cause “upon notice.” In this respect, it is important to insist on an extended “notice” provision, of at least 90 days, to allow the physician to begin to reestablish his or her independent medical practice.
Action Step During the negotiation process, careful thought must be given to how and when a postclosing relationship may be terminated.
Mistake 10 Failing to Consider Where Disputes Will Be Resolved
In cases where the practice is sold to a multisite hospital, or another commercial venture is sold to an out-of-state entity, real problems for the physician can arise if the venue to resolve a dispute is inconveniently located. For example, a hospital system might specify that any litigation will be resolved in the city of its corporate headquarters, which could be hours away. If the physician has agreed that venue and jurisdiction are proper in that locale, the provision will likely be enforceable. Obviously, provisions of this nature impose financial and practical burdens on the physician.
Action Step The physician should work to negotiate an agreement that specifies that litigation or arbitration will occur where the physician provides services for the purchaser, or where the physician’s practice or business was located. If that provision cannot be negotiated, efforts should be made to compromise on a location that is not unduly burdensome.
While it is understandable for a physician to focus on “getting the deal done,” a failure to consider the details of a transaction may have significant adverse consequences. By following the steps outlined here, a physician can minimize the likelihood of such consequences and complete a productive business transaction.
Michael Jordan, Esq.
Peer reviewed by:
Robert R. Niccolini, Esq.
Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them