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Roadblocks to practice sale negotiations

By Stuart R. Kaplan, Esq. & Martin J. Stanek, Esq.

More and more physicians in private practices have been selling their practices and going to work for large health care organizations. But negotiating the sale of a physician practice is difficult. As a physician, you will want to get the most for the practice you have built, while hospitals and other purchasers will be looking for a bargain. Some of the more common stumbling blocks encountered in this type of negotiation are: representations and warranties in the purchase agreement, software license agreements and physicians’ retirement packages.

Representations and Warranties

The purchase agreement should protect the interests of both the buyer and seller in a sale transaction, and provides the framework for the deal. In seeking to ensure the buyer knows what he is getting, he will typically ask the seller to make a variety of representations and warranties regarding the practice being sold. Many of these representations and warranties are standard. For example, a seller may reasonably be asked to represent and warrant that he or she:

• Has clear title to the practice and its assets.

• Is able to sell the practice without violating any existing agreements.

• Has accurately represented the financial condition of the practice.

But for representations and warranties such as these to be useful to the buyer, the hospital or health care organization buying the practice must be able to sue the physician and/or his professional corporation if necessary to recover losses incurred as a consequence of one or more of the representations or warranties being false. In addition, the seller must be available to be sued and have adequate assets to cover the losses if the protection sought by the representation or warranty is to have meaning.

The hospital or health care organization buying the practice may therefore insist that a portion of the sale proceeds be placed into escrow for a specified period following the sale. An escrow can provide assurance that funds will be available for recovery, and if the seller learns that a representation or warranty has been breached while the escrow is in place, the buyer can file a claim against the escrowed funds. In addition, if the physician practice has been formed as a professional corporation and there is no escrow established, the hospital or health care organization will often insist that the shareholders of the corporation remain personally liable following the closing for some or all of the representations and warranties made in the purchase agreement.

For a physician selling a private practice, neither option is desirable. Either a portion of the sale proceeds is tied up in an escrow account and remains vulnerable to claims, or the physician faces personal liability. For example, if the hospital or health care organization decides down the road that it is not satisfied with the practice it has purchased, the buyer may file what may be perceived to be a harassing or frivolous lawsuit against the seller. Reasonable people often differ as to whether legitimate grounds for such a claim exist, and as physicians are well aware, our system places few restraints on litigious plaintiffs.

A physician selling a practice generally will want to receive the sale proceeds (i.e., the purchase money) as soon as possible and should take steps to protect these funds. After all, this money is most typically used to fund retirement. One way to reduce the risk of such a post-closing claim is to limit in the purchase agreement the types of claims a purchaser can make against the seller. For example, the physician should attempt to negotiate limits on:

• The amount for which a claim can be brought.

• The period within which a claim can be brought.

• The extent of personal liabilities for breaches.

While these limitations will not entirely eliminate the seller’s exposure to post-closing claims, they can limit the risk of exposure and reduce the likelihood being sued following the sale.

Pension Plans for Highly Compensated Physicians

In most cases, when physicians sell their practice, they go to work for the buyer. Negotiating a fair salary is important, but negotiating retirement benefits may be even more important. Private practices can funnel more money than hospitals can into retirement packages. The average retiree requires an income equivalent to 60 or 70 percent of his or her final annual salary. But federal tax and labor regulations may prevent larger organizations from offering these levels of retirement benefits to physicians.

There are two basic kinds of retirement plans: tax-qualified and nonqualified. Qualified plans must meet more than 30 separate statutory requirements in the Internal Revenue Code to achieve three powerful tax advantages:

• Taxes on plan contributions are deferred until retirement.

• Taxes on plan earnings are deferred until retirement.

• Plan contributions are tax-deductible when they are made.

Qualified plans are desirable because of the tax advantages. But because of nondiscrimination and other federal law restrictions, they usually can deliver only a modest level of retirement benefits. When a physician is employed by a hospital or large managed care company, the gap between what a qualified plan offers and what a physician needs for retirement must often be bridged with a nonqualified plan.

If the employer is a nonprofit organization, there are often federal law limitations which make it even harder to provide adequate retirement benefits. For example, an employee of a nonprofit organization can defer a maximum of only $7500 per year of income into a nonqualified retirement plan—not nearly enough. There are ways to increase the nonqualified benefits a nonprofit can offer, including equity split dollar and possibly severance pay plans, but these strategies are risky and may not produce the desired results.

Another option for a nonprofit is to form a for-profit venture, which can then hire the physicians and provide services to the health system. Employees of a for-profit venture generally can defer any amount into nonqualified retirement plans, although such a for-profit must be operated separately from any nonprofit affiliate.

While nonqualified plans can bridge the gap, they are not nearly as secure as qualified plans. A company’s creditors may go after money in a nonqualified plan if the organization goes into bankruptcy. Security for the physician can be increased somewhat by using “rabbi” trusts, annuity contracts, life insurance, surety bonds and letters of credit.

Software Agreements

Hospitals and health care organizations will often carefully review the software license agreements of a physician practice they intend to acquire. They also need to examine their own software license agreements. At issue is whether the acquiring hospital or health care organization may use the physician practice’s software databases, other computer records with patient medical and billing information and, if applicable, software systems to incorporate the practice into their organization.

The acquiring organization is likely to follow one of two post-acquisition software usage scenarios, or some combination of the two:

• The acquired physician practice will keep using its existing information systems, in which case it may be necessary to assign its software license agreements to the acquiring hospital or health care organization. New interfaces between the physician practice and the acquiring organization may be necessary to centralize record keeping.

• The physician practice will not use its existing software after the acquisition, but will transfer its records to the acquiring hospital or health care organization’s information systems.

Terms of the existing license agreements of the acquired physician practice or acquiring hospital or health care organization could affect both of these options.

Vendor-proposed license agreements may favor the vendor, but the terms generally are negotiable within reasonable bounds. Some common red flags in standard vendor-proposed software license agreements are:

• A successor to the licensee has no right to use the software, and the licensee cannot assign the license agreement to any successor or acquiring organization.

• The software is usable only at a specific location, which may not fit the needs of the post-acquisition organization.

• There is no option to add users, or there is a cap on the number of users that inhibits the effective use of the software by the post-acquisition organization.

• A long-term service contract isn’t cancelable and the post-acquisition organization must pay continuing support payments for software that it will not use.

• There are penalties for terminating the license or support agreement.

• There is no requirement that the vendor cooperate with other software vendors in the transition to another software system or to interface the existing system with software systems the post-acquisition organization uses.

Private practices anticipating a future sale should review its software license agreements to make sure that the rights will transfer to a successor. Hospitals and health care organizations acquiring a private practice should not overlook software license agreements which could render the practice’s data worthless.

These are only a few of the many considerations in selling a physician practice. Negotiations may begin by establishing a price for the practice. But in addition to getting a good price, the physician should try to limit his or her liability in the sales agreement so the proceeds of the sale are immediately available and the risk of future lawsuits is diminished. Finally, a physician should negotiate for a good salary and benefit package from the buyer who will become the new employer.

Stuart R. Kaplan, Esq., and Martin J. Stanek, Esq., are attorneys with Eckert Seamans Cherin & Mellott, LLC, a national law firm headquartered in Pittsburgh. Mr. Kaplan is a member of the firm’s health care practice group and Mr. Stanek is a member of the firm’s corporate practice group.

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