Leasing the practice: An end-run to acquisition
Legally Speaking
By Alice G. Gosfield, Esq., July 1, 2020
Every month, Dermatology World covers legal issues in Legally Speaking. This month’s author, Alice G. Gosfield, Esq. is a health care attorney at Alice G. Gosfield and Associates, P.C.
Since the passage of the Affordable Care Act, the dynamism in the transformation of the health care delivery system structure has been undeniable. From the acquisition and employment of specialists by health systems, to the interests of private equity in certain kinds of practices including dermatology, to mergers of physician practices into mega-groups, there are a host of choices to make, including doing nothing different, while working to improve the value of the practice by itself. That said, one of the less understood options is the practice of leasing the practice to the health system or hospital, while it remains intact, employing its own physicians.
I have worked on many of these transactions around the country for a variety of specialties including cardiology, gastroenterology, critical care, orthopedics, urology, oncology, surgery, and multi-specialty groups. I have not seen a dermatology stand-alone practice do this, but that is likely because they don’t generate business for the hospital per se. However, the heavy cash flow of the cosmetic side of dermatology might well be appealing to hospitals who are facing their own revenue pressures.
The purpose of this article is to introduce the basic concepts associated with this type of transaction.
Advantages of leasing your practice
The group remains intact. It continues to employ its personnel and own its furniture and equipment. The primary advantage is that if the transaction doesn’t work, it is merely a contract termination or expiration without the necessity to reconstitute the group and rehire personnel. The group reassigns its right to be paid to the hospital, which guarantees a fixed rate of compensation to the group as a whole for the production of a pre-determined quantum of RVUs (relative value units) for a year. This provides the group with financial stability. The hospital takes the risk of effective billing (more on that below). The hospital pays for the overhead and expenses of the group, typically based on a budget, but sometimes the wRVU (work RVU) rate is valued to take into account the overhead and expenses. What is included as expenses and what remains the group’s responsibility is the subject of negotiation.
In the transactions I have done, I have pushed for no dollar-for-dollar reconciliation of each RVU the group produces against the compensation paid by the hospital. We have established a corridor of productivity, so if the group produces above a threshold in productivity, they are paid an additional wRVU rate. If they fall below a lower threshold for a period, say a quarter, the compensation is lowered as agreed by the parties at that time. In the first transaction I did in 2010, the corridors were 8% up and down for a group of about 15 cardiologists in the Midwest. In a more recent transaction for a group of 31 cardiologists in the mid-Atlantic, the corridor was 2% up and down. Their size meant they could bear a tighter tolerance since the impact would be less, spread across the group.
In addition to the focus on wRVUs, these transactions can incorporate, in the same lease document, all of the other alignment strategies the parties desire. These include co-management even for outpatient clinics, directorships for applicable service lines, and additional payment for enhanced quality performance or avoided complications. All of these can be monetized in today’s world and are payable consistent with the fraud and abuse laws.
Pitfalls of leasing your practice
The first potential problem is the health system’s valuation of the practice. For this I recommend the physician group hire its own valuator from the outset. With someone good, in every deal I have done, the hospital’s numbers have increased as a result of the group’s valuator’s input. Make sure the hospital represents and warrants that they can bill in accordance with the standards of the industry, particularly with regard to timeliness of claims submission, amount of outstanding accounts receivable, and collection rate. Even though they take the risk of billing and collection, if they are ineffective, as is quite common, they can turn around and say that because the group is not generating the anticipated revenues, the agreed upon compensation is no longer fair market value.
Another major pitfall is post-termination restrictive covenants. If the health system does not buy the assets of the practice (which is my recommendation) they don’t have an investment to protect as they would if they invested cash. At an absolute minimum, any post-termination restrictive covenant should be tempered to only prevent a transaction with a competing health system and should not preclude joining a physician group. The ability to do a private equity deal post-termination has recently become a subject of negotiation. Under all circumstances, the records of the group should be returned, and patients that the group brought to the deal should be off limits to any anti-solicitation clause post-termination. Depending on whether they have the right cadre of specialists to take over the patients of the group generated by the health system’s marketing, they may not be able to serve those patients anyway.
Finally, I have increasingly bargained for clients that when they join the hospital through this lease that the system agrees to market them to the same extent as their employed physicians of the same specialty, if any, including by making them equally available in the electronic medical record system which indicates the consultants available for referrals.
Conclusion
Where the lease transaction is a possibility, it offers some significant advantages to the group. That said, I have had multiple instances where the first part of the transaction has required my educating the health system administration and legal counsel regarding both the legalities and practicalities of these transactions. I recommend their consideration among other choices groups are considering in the current environment.
