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Extricating Yourself From the Hospital System

MANAGED CARE April 1999. © MediMedia USA

Extricating Yourself From the Hospital System

It seemed a good idea to sell the practice to a hospital, but it didn't work out. When a doctor wants or has to leave, there are things to negotiate.
Mark D. Abruzzo, J.D.
MANAGED CARE April 1999. ©1999 Stezzi Communications

It seemed a good idea to sell the practice to a hospital, but it didn't work out. When a doctor wants or has to leave, there are things to negotiate.

Mark D. Abruzzo, J.D.

Caught in the riptide of change, hospitals in many regions have ventured into the private practice of medicine in the past 10 years in an effort to maintain an adequate stream of referrals. Many have formed "networks" by purchasing primary care practices.

At present, all is fairly quiet on the acquisition front, but the next few years figure to be busy again — in a different sort of way — as many hospitals and physicians undo their acquisitions in some fashion.

Most hospitals and hospital systems (I'll refer to them all as "hospitals") are just now taking inventory of what they've acquired and how costly their acquisitions are from an operations perspective. Those early years, particularly the first 3 to 5, are critical.

Most experts figured that hospital systems would struggle to operate and manage medical practices and that they would lose money. For the most part, they have. Some reports indicate that hospitals in the East are losing $100,000 for each practice acquired. Whether, and to what extent, hospitals are losing money is subject to some debate. The biggest reasons for loss, they claim, are decreased production from physicians and corporate costs associated with management. There is probably much truth to this.

In any event, many of these hospital networks will not last long. When the numbers are finally crunched, some will deem the losses too great to continue to sustain. Others may simply rethink their strategy of acquiring practices as a defensive maneuver unnecessary in the current market.

There is little doubt that some hospital systems will not only survive but gain strength as well; those systems will be busy renegotiating with physicians whose contracts come up for renewal (most contracts last 3 to 5 years).

In addition, there are sure to be physicians who desire to terminate their contracts — either before or upon the expiration date — viewing the relationship as a mistake. It's just as sure that hospital systems will be looking to terminate certain physicians on or before expiration.

Consequently, the next few years will be busy with physician extrication and expulsion from hospital systems.

Assess the relationship

Before taking any action, each party needs to assess the relationship and, particularly, causes for strain. These are evident if, for example, the hospital system intends to file for bankruptcy or to be acquired by another system.

Other causes may be less obvious. A physician might contemplate leaving a hospital system for any number of reasons ranging from incompatibility with hospital administration (or the office staff assigned by the hospital) to increased patient load resulting from a greater assignment of capitated contracts.

Whatever the reasons for the strained relationship, it will be important to understand and appreciate them to get to the next step. Getting there will also require goals and objectives. Only when the parties acknowledge their problems and have direction will they come to a workable resolution. Does the physician aspire to have his practice returned? Does he want to join another hospital system or an independent physician group? Does the hospital desire to cut costs? Will it allow a departing physician to compete?

Determine the alternatives

The alternatives will generally be restructuring the current relationship, selling back the practice on previously agreed terms, or terminating the relationship, requiring the physician to seek a new position.

The apparent obvious choice, from the physician perspective, would be to buy the practice back, but a high ranking official of a southern hospital system once predicted to me that this would not be the case. Although he expects many physicians to experience an uncomfortable transition from ownership to employment, and while he thinks they will find things to complain about with respect to their new environment, he firmly believes that once they become acclimated, the vast majority of physicians will not want to return to the hassles and rigors of ownership.

Revisiting the contracts

The physician and the hospital will have to review the employment and purchase contracts. The employment agreement is likely to provide the framework for termination. This isn't to say that the parties cannot make up new rules, but if separation is not mutually desirable, the party desiring to terminate the contract may face a stiff challenge in light of provisions in the agreements.

In the case of a physician desiring to terminate his contract, for example, the noncompetition covenant could be a formidable obstacle. On the other hand, if a hospital's administrators believe that a separation is best for the hospital and that the physician's referring patterns will not change as a result, then it may agree to waive the noncompetition covenant.

Furthermore, waging public battles with physicians over enforcement of noncompetition covenants could have disastrous public relations implications for a hospital.

It is doubtful, but possible, that the agreements would provide a right of repurchase. If they do, that option would be available immediately according to the specified purchase terms, although this does not necessarily foreclose any opportunity for further negotiation.

On the flip side, the purchase agreement may require the physician to forfeit part of what he was paid for the practice if he seeks to leave before a specified date and/or, similarly, to pay damages of some sort.

These and any other terms in the employment and purchase agreements will constitute a starting point for negotiations. The restrictive covenant is a complex subject, but it's worth mentioning that any physician seeking to circumvent one will fight an uphill battle. A restrictive covenant in the initial practice acquisition and employment agreements is likely to be enforceable.

While unreasonably strong covenants are sometimes thrown out by courts, most hospitals draw up the covenants carefully, reducing the odds of nonenforceability.

Furthermore, courts are generally more inclined to enforce restrictive covenants when they are part of the sale of a practice to a hospital than when they are merely part of an employment contract, since the physician was compensated for transferring the practice.

Practical issues

There are other issues as well pertaining to separation, many of which should, but won't necessarily, be addressed in the agreements:

Malpractice insurance. A physician will need to line up professional liability coverage. If he cannot take his policy with him, he will need to apply for new coverage. This will take a few weeks. Insurance companies may underwrite retroactively, but they're not inclined to do so for a long period.

If the terminating policy is underwritten on a claims-made basis, who will pay for the "tail" coverage — coverage against claims made after the policy's termination date? The employment agreement is likely to spell this out — probably requiring the physician to make the payment. However, this can be part of a negotiated settlement. In any event, tail coverage will not be needed if the physician takes the policy with him, so this should be considered.

Assignment of rights to employment arrangements. The physician's rights to his old staffers are not likely to be an issue — the hospital would have no use for them if the physician were taking back the practice. However, if the physician leaves and competes, he will have no legal rights to them. In addition, the physician may be prohibited under the terms of the agreements from inducing them to leave the hospital to work with him. Some agreements will go so far as to restrict outright the employment of any hospital employee. The departing physician, then, may need to hire a new staff to re-establish the practice.

Assignment of tangible assets. As with personnel, a physician's tangible assets should be returned to him with the practice. In a termination, however, the hospital is likely to desire retention of those assets if it replaces the physician. Consequently, the physician desiring to reconstitute a practice will need to acquire furniture, equipment, and the like.

Things can get really complex if the hospital is in bankruptcy. The physician could lose tangible assets even if entitled to them under the agreements. From the physician perspective, extrication prior to bankruptcy can be greatly beneficial.

Assignment of contracts. Often overlooked are contracts with landlords, insurers and HMOs, and vendors. As with personnel and tangible assets, the hospital would have little use for the office lease if its intention is to return the practice to the physician. The same may also be true in a termination where the hospital desires to retain the practice. If the hospital decides to consolidate office arrangements or find new space for that practice, then the office lease may be available to the departing physician — assuming he is permitted to pick up the pieces and compete.

Contracts with vendors and payers are not so much at issue. Many of them are with the physician, individually. Where this is not the case, the hospital should neither desire nor be able to prevent the physician from entering into new arrangements.

Establishing provider numbers. The physician will need to establish new billing numbers or reactivate prehospital billing numbers. Until such numbers are obtained, the physician cannot bill for services rendered after leaving the hospital. It can take 4 to 8 weeks, depending upon the payer, to obtain billing numbers.

Notification to patients, vendors, creditors, and others. These parties were alerted when the physician went to work for the hospital, and he will have to let them know when he leaves. The difference this time is that the physician will have to do these things, whereas the hospital probably took care of the details the first time.

The hospital may have keen interest in patient communication. Consequently, patient notifications will probably be a subject of negotiation.

Patient records. When the physician sold the practice to the hospital, the patient records became the hospital's legal property. Restrictive and nonsolicitation covenants notwithstanding, the hospital must respect a patient's request to transfer records to the physician. The hospital will most likely insist on retaining copies. The parties will be left to negotiate financial responsibility for copying costs.

Start-up capital. Since he will have no rights to accounts receivable upon departure, the physician will need to borrow start-up capital if reacquiring or re-establishing a practice.

Formation of legal entity. The physician who reacquires a practice or who decides to establish a new practice may also want to form a legal entity (perhaps a corporation or a limited-liability company). He'll have to file papers with the state, because he would actually be reacquiring the assets, not the legal entity that he used to own.

And that's not all. Just as when he set up practice the first time, there are plenty of other things to do such as obtaining business insurance coverage and contracting for employee and personal benefits.

Moreover, this is not an exhaustive list of the necessary items. Physicians will need advice from experts on matters ranging from negotiation with the hospital to review of new employment opportunities and agreements to assistance in reacquiring a practice or establishing a new one.

The author is a partner in the Berwyn, Pa.-based law firm of Wade, Goldstein, Landau, Abruzzo, Mackarey, & Davidson. He counsels physicians, other health care providers, and other business organizations on all areas of business, corporate, and partnership law.

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