Transferring Your Medical Practice - An Often Overlooked Asset

If you would like more information about this topic or any other topic contact Scott Einiger

With increased frequency in recent months, the media has focused national attention on the ongoing consolidation taking place in the healthcare community. On almost a daily basis there are reports of the most recent merger, consolidation or purchase of medical practices by various entities. This attention has heightened awareness for individual physicians in solo and group practices concerning the salability of their professional practices that often may be their largest (and most overlooked) asset. This article is the first in a two part series which will outline the process to be followed by the physician planning to transfer his/her medical practice due to retirement, relocation out of state or in anticipation of the changing health care environment. In this part we will review liability concerns facing the physician contemplating the termination or transfer of his/her medical practice. In part II, we will address the financial and legal issues arising in the purchase/sale transaction.

Part I. Pre-Termination of Practice - Liability Avoidance Considerations

A. Abandonment

Abandonment is a form of professional negligence that occurs after a duty (physician patient relationship) has been established by not properly disassociating oneself from the professional relationship (i.e., failing to provide adequate notification which would enable a patient to seek alternative healthcare) causing an injury to the patient. In fact, the law mandates adequate notification be given to patients to ensure continuity of medical care. What will constitute adequate notice is dependent upon the patient's individual treatment, however, a general rule of thumb is to provide at least four weeks notice prior to termination or transfer of medical care. In selling a medical practice, a physician should begin planning the transfer of his/her practice six months to one year in advance to allow sufficient time for the orderly transition from seller to buyer and to avoid claims of abandonment.

Typically, when the selling physician transfers his/her practice, the buying physician is introduced to patients by letter which serves a dual function. First, the letter advises the patients of the seller's intention to transfer the practice, the patient's need to obtain continuous care (preferably from the purchasing physician) and the date the selling physician will no longer be available. This letter notification further serves to insulate the selling physician from a claim of abandonment. Second, the letter serves as an introduction of the new physician purchasing the practice, setting forth his/her outstanding credentials and the seller's endorsement which will help the purchaser retain as much of the patient population as possible. This letter must be carefully constructed with the input of both buyer and seller to ensure that the interests of all parties are protected.

B. Confidentiality/Retention of Medical Records

It is important to note that the sale of a physician's medical practice does not include the sale of medical records which is prohibited by law in New York and most other states. A physician may not sell his/her medical records as part of the transfer of their practice since those records and the information contained therein are confidential. (The assets that make up the value of the medical practice will be discussed at length in part II of this article). Rather, the physician who purchases the practice typically becomes the custodian of the patients' medical records. This means that the transferred records will be retained by the purchasing physician for the relevant statutory period (see below). Thereafter, treatment will either continue to be rendered by the purchasing physician, or a copy of the records will be made available to the patient in the event that they wish to see a different physician. Until a patient authorizes or consents to treatment, the purchasing physician may not review the patient's medical chart. Authorization to review the medical chart or consent to continue treatment may be express (written authorization) or implied (when the patient comes in for an appointment). A good practice which encourages patients to continue their treatment with the purchasing physician is to include an authorization in the introductory letter. The authorization is then completed by the patient and identifies their wishes concerning future medical treatment.

In New York, medical records must be retained in accordance with Board of Regents regulations. The failure to retain records for the statutory period would subject the physician to disciplinary action by the Office of Professional Medical Conduct. At a minimum, the records of adult patients (18 years of age or older) must be kept for six years from the last date of treatment. For treatment of minor patients (person under the age of 18), the rule requires that the records be retained the longer period of six years from the last date of treatment or until the minor reaches 19 years. When a medical practice is sold, the selling and purchasing physician each have an interest in ensuring that the records will be retained in accordance with the applicable period. It is recommended that the issues of retention and confidentiality of medical records be addressed in the contract of sale.

C. Malpractice Insurance

In the case of a physician who is retiring from practice, written notification to his/her Professional Liability Insurance Carrier should be given to effectuate policy cancellation. Physicians who anticipate working on a part time basis, whether due to retirement or relocation after a sale of practice is completed, may be eligible to pay a reduced insurance premium for that period. We recommend contacting the underwriting department of your insurance carrier to discuss these issues.

There are two basic forms of professional liability insurance offered in New York: occurrence and claims made coverage. While the coverage afforded by both policies are identical, the chief difference is found in the pricing structure and the protection that is afforded once the policy is canceled.

When canceling liability insurance, it is important to determine the form of policy (i.e., claims made or occurrence) that you are covered under. If you have a claims made policy, it is essential that you either purchase a reporting endorsement (a.k.a. "Tail") or, in limited instances you may receive such an endorsement free of charge. In the event of death, disability or retirement, physicians may qualify to receive a reporting endorsement at no additional cost. This endorsement is essential in protecting you in the event that a claim is instituted after you have canceled your insurance policy. If you are covered under an occurrence policy you are protected for claims arising from incidents that occurred while the policy was in effect no matter when a claim is reported ... even if it occurs long after the policy has been canceled. Thus, a reporting endorsement is not applicable to this form of coverage.

D. Biennial Registration

Since 1991, physicians in New York have been required to register on a biennial basis with the State Education Department, Division of Professional Licensing - Registration Unit [518/474-3817] and pay the applicable registration fee. Whenever, a physician withdraws from the practice of medicine, (s)he is not required to pay the registration fee but rather may notify the Division of Professional Licensing - Registration Unit that they wish to place their license in an "inactive" status. While an "inactive" physician is not required to pay the biennial registration fee, it is important that (s)he continue to complete the biennial registration forms indicating their inactive status to avoid a late fee in the event that they wish to resume practicing medicine at a future date. When a physician relocates due to retirement or sale of the medical practice, any change in mailing address should be reported to the Division of Professional Licensing - Registration Unit to ensure future receipt of registration forms.

E. DEA Certificate and Controlled Substances

The sale of your medical practice would not include the transfer of controlled substances. Controlled substances are not considered assets that can be sold to the purchasing physician. They must either be returned to the manufacturer or licensed distributor (who will in some instances provide you with a refund for returning unused medications), or surrendered to a person approved by the NYS Department of Health - Bureau of Controlled Substances ("The Department"). Recently, the law has been amended to enable physicians to destroy controlled substances in the presence of two qualified witnesses. However, permission must be requested in writing two weeks prior to the intended destruction, and approval must be received from The Department. The law also requires that physicians maintain a written record (for at least five years) concerning the disposition of the controlled substances. We recommend that you contact The Department office in your area regarding the specifics of the destruction protocol and written record requirements.

Physicians retiring from practice can surrender their DEA Certificates by contacting the Drug Enforcement Administration located at 99 10th Avenue, New York, New York 10011, 212/337-3900.

F. Review of Contractual Obligations

Physicians terminating or transferring their medical practices must undertake an analysis of existing contractual agreements which will affect the proposed sales transaction. These agreements must be reviewed for two distinct purposes. First, it must be determined whether the contractual obligations of the seller may be terminated. For example, the selling practitioner may have obligations under employment agreements, and/or various vendor agreements. These agreements may survive the sale of a medical practice, obligating either the selling or purchasing physician to fulfill whatever terms are contained therein. On the other hand, transferable agreements may exist which can be of potential value to the purchasing physician. Agreements falling into this category include real estate leases which call for rental payments which are below current market value. Under these circum-stances, it must be determined whether the purchasing physician can assume these beneficial agreements. Additionally, prospective purchasers must inquire as to whether the selling physician has contracted with managed care organizations. Managed care contracts often increase the number of patients of a medical practice. However, these contracts are deemed to be "personal service" contracts, and thus are rarely assumable by the purchasing practitioner. For physicians who are not approved providers within the sellers managed care network, the managed care contract would be of no value and thus, a purchasing physician must discount the managed care patients of the practice when determining the number of transferable patients. However, if the purchasing physician is an approved provider within the same managed care network as the seller, the purchaser will be able to continue treating these patients, and therefore the managed care contract will be a potential asset. A physician who is selling, purchasing or retiring from practice must carefully review all outstanding contracts to determine whether such agreements are either assumable or may be terminated. This will help to ensure that the interests and objectives of all parties will be furthered.

G. Conclusion

This concludes our overview of the salient issues to be evaluated prior to transferring or retiring from a medical practice. It is intended to serve as a guide to highlight various areas of potential liability for physicians. This article should not be construed as legal advice. It is recommended that an attorney be consulted in order to discuss specific issues related to your particular transaction. In part II of this article, we will discuss specific financial and legal issues arising in the purchase and/or sale transaction.

Transferring Your Medical Practice - An Often Overlooked Asset

Part 2 By: Scott I. Einiger, Esq.

Jeffrey R. Ruggiero, Esq.

Editor's Note: This article is the second in a two-part series outlining an overall process for the physician planning to transfer a medical practice due to retirement, relocation or in anticipation of the changing healthcare environment. In part one, we reviewed pre-termination and liability avoidance issues. In this part, we address financial considerations and legal issues that arise in a medical practice purchase/sale transaction.

As a first step in the sale process, long before initiating price negotiations, the selling practitioner should obtain a valuation of the practice to properly determine the intrinsic value.

A medical practice valuation must entail a thorough appraisal of all property, which includes both tangible and intangible assets. While the methods of valuing tangible assets vary and depend upon many factors, valuation methods frequently utilized include "capitalization of earnings method," "capitalization of excess earnings," "discretionary cash method," "the discounted future earnings method," and the "formula or rule of thumb method."

Accountants and medical practice consultants commonly use the first four of these methods and typically provide a comprehensive report based upon generally accepted accounting principles. However, a physician can initially approximate the general value of the medical practice by using the formula or rule of thumb method.

The formula or rule of thumb method has been referred to as the "laymens" approach to valuating a business concern. This method is usually a function of market value, and will often reflect the value of a business on the open market. A formula which is frequently used entails totaling the gross revenues for the past five years then dividing by a factor of five to obtain the average gross revenue.

Thereafter, the value of extraordinary assets would be added to the gross revenue figure. Examples of these assets would include real estate, durable medical equipment or other assets reflecting substantial capital expenditures. Finally, a value would be added for goodwill or other intangible assets.

This sum will reflect a general approximation of the value of the practice and constitutes a point of reference for the physician. However, it is highly recommended that the services of accountants and/or appraisers are secured to render an expert opinion regarding the value of the practice prior to commencing the price negotiation process.

Depending upon the value of the transaction, it is not uncommon for both the seller and purchaser to engage the services of such experts, and then use the respective valuations in price negotiations.

Tangible Assets

Tangible assets consist of property of all kinds, both real and personal, which can be felt or touched. Often the value of these assets can be readily determined to a reasonable degree of certainty.

Common examples of tangible medical practice assets include real estate, equipment (medical and nonmedical), inventory, medical supplies, furniture, and office fixtures. It is important to determine the purchase dates of depreciable assets so that their value can be ascertained. The value of these depreciated assets reflect a decline in the value of such assets caused by wear or obsolescence and is usually established by a set formula measured over a stated period of the useful life of the asset.

It is recommended that the selling practitioner create a comprehensive list of all tangible assets which are to be transferred. The physician purchasing a medical practice should receive this detailed list well in advance of contract execution, and should physically review these assets for verification.

Intangible Assets

Intangible assets are comprised of property to which an "arbitrary" dollar value is attached. The dollar value of intangible property is considered to be arbitrary since the value of these assets represents the difference between the actual purchase price of a medical practice and the true value of the net tangible assets.

Goodwill is the primary example of an intangible medical practice asset. In the medical practice setting, goodwill essentially represents a positive advantage that has been acquired by a practitioner in developing the medical practice over a number of years.

This advantage can be derived from the practice location, the name under which the practice is associated, the professional reputation and skill of the practitioner in the community, and the continuation of an ongoing concern developed over a number of years.

Other medical practice intangible assets may include telephone listings, contracts with managed care organizations, experienced office staff, assignable lease agreements under which the rental price is below current market value, assignable vendor agreements and non-competition agreements.

Certain assets, by their nature, are difficult to categorize as tangible or intangible. Assets which fall into this category include accounts receivable, patient lists and assignable lease agreements.

Salability of Practice

An often overlooked issue in the purchase/sale transaction is the "salability" of the practice. The concept of salability includes the issue of locating a physician willing to purchase the practice assets for the price established.

Equally important, but frequently ignored, are issues involving the compatibility of the selling and purchasing physicians' practice philosophies. A considerable amount of time and energy will be wasted by all parties if the practitioners' respective philosophies, training and abilities, and in some limited cases, ethnicity, is so disparate that the "new" physician will not be able to relate to the patient population cultivated by the selling physician.

It is important to keep in mind that the selling physician has been practicing for a number of years in accordance with a personal philosophical view toward the physician/patient relationship. The selling practitioner's patients have become accustomed to a certain manner of practice, and will generally expect similar treatment from the new physician. In order for the purchaser to retain patients after the sale, and to ensure a smooth transition, the purchasing practitioner must be able and willing to continue and build upon current physician/patient relations.

Contract of Sale

Once the practice has been valued and purchaser located, a deal will be negotiated which ultimately will be reduced to writing. The contract of sale is a legal document which reflects the written agreement of the parties, and sets forth the terms and conditions of the practice transfer.

In drafting a sales contract, the detail and terms of the agreement will vary depending upon the complexity of the transaction. However, at a minimum, all sales contracts must identify the parties to the transaction, contain a detailed description of the property to be transferred, reflect the purchase price which should include allocations for the specific assets to be transferred, and the manner and method of payment.

Generally, all medical practice purchase/sale agreements contain a list of all the patients of the practice which will be transferred at the closing. Depending upon the size of the medical practice, these lists are often incorporated into the sale agreement by reference, and are actually contained in a separate document. It is critical to realize that the sale of a medical practice does not include the sale of patient records. The sale of medical records is prohibited by law in most states since those records and the information contained therein are confidential.

Instead, the purchasing physician agrees to act as the custodian for the patient medical records. Under these circumstances, the contract of sale should contain a clause which provides that the purchasing physician agrees to receive the transferred records, and further agrees to retain the records in full compliance with retention and confidentiality laws.

From the purchaser's perspective, the contract of sale should contain a "covenant not to compete" or "non-compete" clause.

From the seller's perspective, the contract should provide that all patient and financial records transferred will be accessible to the selling practitioner for a definite period of time subsequent to the closing.

Anti-Referral Considerations

All transfers of physician practices must be analyzed in accordance with the broad federal and state anti-referral laws. These laws prohibit financial inducements in exchange for the referral of patients. However, these prohibitions include two important exceptions or "safe harbors" which protect the sale and purchase of physician practices.

Under federal legislation, the "practice sale safe harbor" permits the sale of a medical practice between practitioners. This safe harbor also applies to sales of corporations or partnerships involving more than one practitioner as buyer or seller. Two standards must be met for the practice sale safe harbor.

First, the time period from the date of the first agreement pertaining to the sale (typically the contract of sale) to the completion of the sale may not exceed one year.

Second, the selling practitioner may not be in a position to make referrals to, or otherwise generate business for, the purchasing practitioner after one year from the date of the first agreement pertaining to the sale.

Under current New York law there is an exception for the "isolated" financial transactions between practitioners. In order for this exception to apply, two standards must be met.

First, the transaction must be consistent with "fair market value" and have a commercially reasonable basis. Fair market value is defined as the value negotiated in arms length transactions, which is consistent with the general market value, i.e., the value may not be based upon a guaranteed stream of future patient referrals.

Secondly, the transaction must not be tied in any way to the volume or value of patient referrals from the seller to the purchaser.

Federal and most state laws permit "bona fide" employment relationships between practitioners subsequent to the closing of sale.

This employment exception allows the selling practitioner to become an employee of the purchasing practitioner for a period of up to one year subsequent to the sale. The employment arrangement is often critical since it allows for a transition period wherein the selling practitioner remains as an employee of the purchasing practitioner to help facilitate the transition and transfer of patients.

It is recommended that the employment arrangement is set forth in the form of a written employment agreement between practitioners. At a minimum, this agreement should set forth the respective rights, obligations and responsibilities of the practitioners, as well as compensation to be paid.