Friendly Physician Models: The Basics Through Five Frequently Asked Questions
Article originally published on Communique, October 2023
During the past several years, many health law practices have noticed a dramatic increase in the number of telehealth businesses and private equity-backed healthcare providers. Both of these trends often rely heavily on corporate structures commonly referred to as “friendly physician,” “captive PC” or “MSO” models. Although friendly physician models are used by non-physician healthcare providers (e.g., physical therapists, psychologists and dentists), this article focuses on physicians and how the model is used in connection with the provision of professional medical services. Below is a summary of some of the questions often asked by law firm clients as these organizations are structured, developed and operationalized.
Why Do Organizations Adopt a Friendly Physician Model?
Friendly physician models have developed as a result of state law commonly referred to as the corporate practice of medicine doctrine. In corporate practice of medicine states, non-physicians are unable to own an entity that employs or contracts with physicians to provide professional medical services. These entities must instead be owned by licensed physicians. Many corporate practice of medicine states require that physician owned entities that provide professional medical services be organized as professional entities that satisfy certain state-level organizational requirements. The doctrine is intended to protect the independent medical judgment of physicians—to protect the sanctity of the physician-patient relationship.
Over 30 states have adopted some form of the corporate practice of medicine doctrine pursuant to either statutes or case law. Each state’s requirements are unique. States such as New York, California and Texas have robust corporate practice of medicine doctrines that are actively enforced. Other states are less stringent. Some states like Michigan permit certain entities to be owned by physicians licensed in other states, while some states limit ownership to physicians licensed in the state. The process in New York and Illinois to form a professional entity often takes months but professional entities in other states can be formed within an hour. In Florida, unlicensed individuals may own a medical group, but the group is generally required to obtain a Health Care Clinic Act license if not physician owned. Organizations that provide professional medical services in multiple states need to review these laws carefully on a state-by-state basis as the geographic footprint of the organizations evolve.
What Is a Friendly Physician Model?
Friendly physician models are used to permit non-physicians to indirectly invest in physician practices when the state law prohibits non-physicians from directly investing. In general, a friendly physician model involves at least two entities: (a) a professional entity that is owned by one or more licensed physicians, and (b) a management services organization (or MSO) owned in whole, or in part, by nonphysicians.
In a friendly physician model, the professional entity employs or contracts with physicians and other licensed healthcare professionals and is the direct provider of medical services to patients. The patients pay the professional entity for the services rendered. The professional entity is often enrolled with Medicare, Medicaid and/or third-party payors unless the practice is cash based. The professional entity also typically maintains the professional liability insurance covering the services provided.
The management entity may have both physician and non-physician owners. The management entity often provides a turnkey operation to the professional entity. Typical management services provided by the management entity to the professional entity include, for example, the following: (a) development services; (b) provision of real property; (c) provision of information technology and other equipment; (d) provision of office and medical supplies; (e) purchasing and contracting guidance; (f) provision of support personnel; (g) human resource services; (h) patient and case scheduling services; (i) training; (j) credentialing guidance and payor contracting; (k) billing and coding services or advice; (l) financial management, cash management, accounting and related reporting; (m) compliance, quality and risk management activities; (n) intellectual property; and (o) marketing services. In exchange for the management services provided, the professional entity pays the management entity a management fee.
What Are Some of the Regulatory Considerations Often at Issue When Structuring a Friendly Physician Model?
In addition to addressing the nuances of the applicable states’ corporate practice of medicine doctrine requirements, friendly physician models are often carefully structured to mitigate risk under the federal Anti-Kickback Statute and parallel state laws and state fee-splitting requirements. Common safeguards to mitigate regulatory risk include ensuring that the management fee is within the range of fair market value for bona fide services actually provided, is not a percentage-based fee or other fee that varies based upon the volume or value of services provided to patients, and is set in advance and not changed more than once a year. In general, it is advisable to have the management fee be a flat fee or based upon a cost-plus structure.
A third-party valuation of the management fee by a qualified and experienced healthcare valuation consultant is typically advisable but usually not per se required. In the event that the parties make a reasonable good faith determination of what the management fee should be, such determination must be reasonable and documented. Attorneys, even those that focus on heath law, are generally not qualified to opine on what is or what is not within the range of fair market value. When valuation consultants are engaged, it is often a good idea for attorneys to engage the consultants under attorney-client privilege.
How Do Investors Protect Their Interests in a Friendly Physician Model?
In addition to mitigating regulatory risk by incorporating safeguards as discussed above, non-physician owners of the management entity want to protect their investment and limit financial risk from a business perspective. One way to do that is through buy/sell provisions that provide that non-physician investors can essentially replace the friendly physician owner of the professional entity with another licensed physician in various circumstances. These agreements are often called nominee agreements or member transfer restriction agreements.
How Can Friendly Physicians Limit the Financial and Legal Risk Associated with Being the Owner of the Professional Entity That Provides Professional Services?
There are several ways that physician owners of professional entities within a friendly physician model can mitigate legal risk. First, physician owners should ensure that the friendly physician model is structured properly and includes safeguards to mitigate regulatory risk. See discussion above. Second, the physician owners should ensure that those managing the day-to-day operations cause funds to flow in accordance with the governing documents. Legal documents are not helpful if they do not reflect reality. The structure needs to be respected. Third, physician owners should ensure that the organization has an active and robust healthcare regulatory compliance plan and that the culture of compliance starts from the top.
The healthcare regulatory enforcement environment is often punitive. Physicians have a license to lose and non-physician investors typically do not. Accordingly, physicians have more risk than non-physician investors in the event of non-compliance. Fourth, physician investors should understand whether the governing documents require the physician owner of the business to make capital contributions, cover management fee payment shortfalls or personal guarantees. They should confirm that such provisions are acceptable and have their own attorney review the documents before signing.