In our practice of assisting physicians with contracts, we are privileged to see a large volume of “deal flow.” Recently, physician income guarantee agreements are enjoying a resurgence. These are the agreements in which a hospital entices a physician to relocate to the hospital’s service area to set up a new private practice, or join an existing group practice. The hospital guarantees that the new recruit will achieve a certain level of income in first and possibly second years of practice. If he or she does not, the hospital will make up the difference with a check. Technically, this is a “loan” to the doctor, but the “loan” is forgiven if the physician remains in practice in the hospital’s service area for 2-4 years after the guarantee period.
The deals we have seen recently all involve physicians who are joining existing group practices. The income guarantee serves to alleviate the concerns of the group that if it hires the new physician, the senior doctors will be forced to take a pay cut to fund the new doctor’s salary, as that doctor ramps up his or her practice.
Here are 7 core legal and business pointers about the guarantee agreements, from the group’s perspective.
- Specialties and Localities. The classic income guarantee deal involves a primary care or OB physician and a rural hospital. But there is no prohibition against other specialties and localities. We have, for example, seen a guarantee provided to recruit an orthopod to a suburban hospital. The bottom line is that the specialty be one in which patients are admitted to the hospital, or have procedures done in the hospital (otherwise the hospital has no interest). Also, if the hospital is tax-exempt, it must under IRS rules be able to demonstrate (such as with a consultant analysis of physician-population ratios) that there is a need in its service area for additional physicians in the target specialty.
- Covering Overhead Costs. Ideally, the group would like to calculate the new physician’s income as his revenues less his equal share of group practice overhead. This minimizes the “income” of the new doctor, for purposes of the guarantee calculation, and maximizes the chances of getting funds from the hospital. However, under recent Stark regulations, the group practice cannot “lay off” existing overhead on the new doctor in this way. It may only allocate to him the incremental costs associated with his hiring, such as recruiting fees, malpractice premiums, a newly hired nurse to support the new doctor, and other costs that would not have been incurred but for the recruit’s arrival.
- Non-Compete Restrictions. Prior to 2007, the Stark law prohibited the sponsoring group from imposing ANY non-compete restriction on the new recruit. In 2007, the rules were changed to allow a “reasonable” non-compete clause. However, many hospitals still will not allow them; the hospital wants the doctor to be free to continue practicing in the service area, if for some reason the new recruit doesn’t get along with his new group practice colleagues. This presents the group practice with a dilemma. What is more important: the funding from the hospital, or the protection of a non-compete?
- Liability. Under Stark, the hospital, the group practice, and the physician must all sign the income guarantee agreement. One of the provisions in this agreement will be allocation of responsibility for repayment of the “loan,” if the physician leaves town before completing the period needed to fully “work off” the loan. Sometimes both the group practice and the physician are liable for repayment, and sometimes only the physician. This is a matter for negotiation among all parties. The hospital will typically want to preserve as many potential sources of repayment as possible. However, the group will not want to be “on the hook” for repayment, nor will the physician. The ultimate allocation is generally negotiated. If only one party is on the hook, it oftentimes ends up being the party who received the hospital’s dollars (physician or group).
- Taxes. As noted, the party who receives the funding dollars (group practice or physician) has received a “loan” that may or may not be “forgiven,” depending on whether the physician completes the requisite term of service in the hospital’s service area. There is no taxable income to anyone when the loan dollars are paid to the group or the physician, but there is taxable income to the group or physician (whoever received the original funding) when the loan is forgiven in the following years. This is confusing and awkward for all parties, especially the young recruit. The taxable income arrives long after the cash has been received, and thus feels like “phantom income” (paper profit on which real taxes must be paid, without the cash to match). There is no perfect solution to this timing dilemma. The party who gets receives the loan dollars is going to get the phantom taxable income. He or she or it must therefore be prepared to exercise discipline in spending the upfront cash received, so that some is left over to pay taxes when the time comes.
- Amount of Benefit. These deals were sweeter (from the group’s perspective) in the old days, when the group could allocate an equal share of overhead to the new doctor. That virtually guaranteed that the amount of “free money” from the hospital would be significant. But the change to incremental-costs-only has reduced the benefit. Also consider this: when the new recruit reaches “break even” (monthly income generated exceeds monthly income guaranteed) most guarantee agreements require that the payback begin. The payback is made out of the monthly profits produced by the recruit that exceed the monthly guarantee target. So by the end of the guarantee period, the practice may have repaid all or a substantial proportion of the hospital’s guarantee funds. In this situation, the loan money is less of a “gift” than it is a bona fide short term loan.
- Security for Repayment. A typical recruitment agreement will secure the “loan” with a security interest in practice accounts receivable. Any such security interest should be limited to the receivables generated by the recruit, and should not extend to receivables generated by other group doctors. It should also be subordinated to any line of credit or other bank debt of the practice, which invariably has first priority on all such receivables, as collateral.
Income guarantee agreements are complex, and there are generally many “strings attached” (potentially no non-compete for group, taxes issues, liability issues). Nonetheless, these arrangements may make a critical difference in the hiring decision. If you want to hire a new doctor, but feel that you can’t afford it on your own, consider a hospital guarantee.
Daniel M. Bernick,, Esq., M.B.A. is an Attorney and Principal of Health Care Law Associates, P.C. and The Health Care Group in Plymouth Meeting, Pennsylvania