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Drafting a termination agreement

By Jeffrey B. Sansweet, Esq.

An incorporated medical practice should have in place various executed documents, including a Buy-Sell or Shareholders Agreement, Employment Agreements, Bylaws, and possibly Stock Options and Promissory Notes. An unincorporated practice with more than one owner should have in place a Partnership Agreement or Operating Agreement (for a limited liability company), along with employment agreements for any non-owner doctors. These documents should include, among other things, provisions dealing with ending the relationship. Detailed and complete provisions can help make for a smoother termination. However, often the documents are incomplete, unsigned, out-of-date, or do not address every possible issue that could arise upon leaving a practice, especially if a doctor is leaving under less than amicable circumstances and staying in the area. Therefore, it becomes essential to negotiate the terms of a Termination Agreement in order to provide for as smooth a withdrawal or split-up as possible.

In this article, I will first provide an overview of the types of provisions that should be included in the basic practice documents. The more complete they are, the less work needs to be done with a Termination Agreement. I will then discuss the key issues to be addressed in a Termination Agreement. I will assume that the practice is incorporated for ease of reference, but the same principles would apply in a partnership or limited liability company setting.

An Employment Agreement should provide for a minimum advance written notice to the group for a voluntary withdrawal. Ninety days’ notice is common. If the notice period is much longer, things can become uncomfortable. If it is shorter, the practice may not have enough time to “regroup”. The terms upon which the practice can involuntarily terminate a doctor should also be set forth. A shareholder may only be able to be terminated for certain defined causes, or perhaps without cause upon a vote of all of the other shareholders. The senior shareholder or shareholders may also have a seniority right under a Stock Option which allows him, her or them to force someone out or at least to keep the office, corporate name, telephone number, employees and charts upon a mutual agreement to split-up.

The Buy-Sell or Shareholders Agreement and Employment Agreement should spell out the stock purchase price, separation pay entitlement and manner of payment. Personal guarantees of the buy-out by the remaining shareholders are common. There may be different entitlements depending upon the reason for termination. Such reasons include death, disability, retirement, withdrawal and practicing outside a certain defined area, withdrawal and practicing within such defined area, and an involuntary withdrawal. Death, and sometimes disability, may be covered by insurance. It is imperative that the ownership and beneficiary of any insurance policies are coordinated with the terms of the documents so that it is clear who gets what when and from what source.

Buy-out valuations vary substantially from practice to practice depending upon the philosophy of the shareholders, practice economics, specialty and location. For tax purposes, the stock is often tied to the value of the tangible assets (equipment, furniture, fixtures and supplies). The bulk of the buy-out is often paid by the corporation as deductible separation pay and meant to include the intangible value of the practice (goodwill and accounts receivable). Clearly, if a doctor leaves and competes, he or she should not get a buy-out for goodwill as that asset is leaving with the doctor. Often, that doctor would also not get a receivable buy-out as an additional penalty. However, in many situations there will not be restrictive covenants per se for shareholders as the penalty is not receiving any separation pay. However, for a shareholder who is still in the process of buying in and may not yet be entitled to a large buy-out, a restrictive covenant should be in place. Also, non-solicitation provisions should be included.

Another important provision to have in the documents is the disposition of the net proceeds upon a practice sale. Should they be divided equally among all shareholders? Should there be a sliding scale so that the doctors who have been with the practice longer receive a larger percentage of the proceeds? Should shareholders who have only recently become owners be entitled to only a significantly reduced portion?

The corporate documents should also spell out any special voting requirements. Typically, the documents are silent, which would mean that a majority vote rules. Practices should consider whether certain crucial decisions should require a “supermajority” vote (perhaps 75 percent, 80 percent or all but one of the shareholders depending on the size of the practice) or even a unanimous vote. Such crucial decisions could include the sale of the practice, merger with another group, hiring or firing a non-shareholder doctor, bringing in an associate as a shareholder, securing privileges at a new hospital, accepting a managed care contract, or moving to a new location.

A final issue that is important to address in the corporate documents is the disposition of the patient charts and records. Usually the charts and records stay with the practice, but the doctor leaving can make copies at his expense if so requested by the patient.

Unless the corporate documents are all-inclusive and the split-up or termination is extremely amicable, a Termination Agreement should be done to provide for as smooth a withdrawal or split-up as possible. The remainder of this article will list the key issues to be dealt with in a Termination Agreement, with further explanation where warranted.

• The exact effective date and time of the termination.

• The departing doctor’s role in decision-making prior to termination. Certainly, the departing doctor should not have a vote on any substantive decisions to be made affecting the long-term future of the practice he or she is leaving.

• The financial aspects. The practice’s accountant should get involved in this process as soon as possible. A real or simulated “closing” of the books of the practice should take place on or about the termination date so as to determine the departing doctor’s share of any profits or losses, unless, of course, the documents are clear that this need not be done. The stock purchase price, as well as the separation pay/deferred compensation entitlement needs to be calculated, assuming they are part of the corporate documents. If the buy-out amounts cannot be determined by the termination date, at least the formula for its determination should be set forth and then documented once calculated and attached as an amendment to the Termination Agreement. The payment schedule should also be set forth. If there are no documents in place, the parties will need to negotiate the buy-out. If a departing shareholder-doctor is staying in the area as a competitor, at most he or she should be entitled to his or her proportionate interest in the value of the tangible assets and accounts receivable.

• The handling of accounts receivable upon a split-up. Who will do the billing and collection follow up? How often will payments be made? What verification will be required?

• The resignation as an officer, director and retirement plan trustee.

• Removal as a signatory on corporate bank accounts.

• Removal as a guarantor or surety of any practice debt or lease if permitted by the creditor.

• The orderly transfer of patient records. Often, the original records stay with the practice, and the departing doctor may obtain copies thereof upon the written request of a patient, usually at the expense of the departing doctor. Access is required by law if there is litigation. Occasionally, in an amicable split-up, the doctors may agree upon a division of the records based upon who is primarily responsible for the patient.

• Notices to patients and referring physicians. The exact language of such notices needs to be agreed upon, as well as who will pay for them and who will receive them.

• Personal items to be taken by the departing doctor. If they are substantial and they were paid for by the practice, perhaps the departing doctor should pay the practice for the items.

• The payment of accounting and legal fees of each party. Will the practice pay for everything? Will each party pay their respective expenses?

• Health insurance continuation coverage under COBRA.

• The distribution of the departing doctor’s vested interest in any practice pension or profit sharing plan. The plan(s) may allow the departing doctor to keep his or her funds in the retirement plan trust indefinitely or to withdraw amounts periodically. Other options typically include a taxable lump-sum distribution, an IRA rollover and a direct transfer to another retirement plan. Distribution papers must be prepared and signed by the departing doctor and his or her spouse prior to any distributions or transfers. Usually the practice would incur the administrative expense of the distribution, but the departing doctor may be asked to pay for this especially if the funds are to remain in the trust.

• Restrictive covenants and/or non-solicitation agreements. Will the departing doctor be prohibited from practicing in certain locations for a set time period? If he or she violates said covenant, what are the practice’s remedies? Will there be a prohibition on soliciting patients and referral sources? Will there be a prohibition on soliciting practice employees?

• Does the Termination Agreement supersede the prior written agreements in all or only certain respects? This must be made clear in order to avoid confusion.

• Will there by any security for the buy-out payments?

• Finally, indemnifications and releases. These issues can often be contentious. The departing doctor, on the one hand, wants to leave without any further responsibility. On the other hand, the remaining doctors should not bear the entire risk of a future tax audit, billing audit, employee lawsuit, etc., which may arise out of an act or omission that occurred prior to such departure.

In conclusion, in order to avoid a messy termination or split-up, it is helpful to keep your documentation up-to-date. In most situations, it is also wise to have a Termination Agreement prepared to clear up and finalize any issues not entirely dealt with in the documentation.

Jeffrey B. Sansweet, Esq., is a principal of the Wayne, Pennsylvania health care law firm of Kalogredis, Tsoules and Sweeney, Ltd.

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