Professional Medical Practice Acquisitions and the Corporate Practice of Medicine
Private equity funds have become major players in the professional health care delivery sector in recent years due to acquisitions of professional practices, including physician practices, senior living facilities and the like. Such activity has attracted attention from regulators, policymakers and the public, with a particular focus on impacts on quality of care and potential conflicts of interest for providers. Acquisitions of professional practices by private equity funds involve myriad regulatory and compliance obligations at both the federal and state level, and private equity sponsors should be aware of such obligations in connection with their acquisitions and ongoing involvement with such entities.
The Corporate Practice of Medicine Doctrine
Corporate practice of medicine prohibitions are an important consideration for private equity funds engaged in professional practice acquisitions. Although CPOM prohibitions vary among states (with some states having abandoned the doctrine all together), they generally prohibit non-licensed persons, including individuals and business entities, from practicing medicine or employing physicians to provide medical services. One rationale for CPOM prohibitions is to help ensure that only licensed professionals provide medical care and that non-licensed persons do not influence treatment decisions for business purposes. Moreover, the prohibitions are thought to protect patients against potential abuse that could result from a physician’s divided loyalty between generating profits and providing quality patient care.
The enforcement of CPOM prohibitions also varies among states. Further, CPOM prohibitions typically arise from a mix of statutes, regulations, court decisions, state attorney general opinions and even state medical board position statements. But the specifics of the prohibitions often remain vague and historically have been infrequently interpreted by courts. Nonetheless, failure to comply with CPOM prohibitions can lead to loss of licensure and civil and criminal penalties, and can also cause agreements between a business and a licensed professional to be void and unenforceable.
Common Transaction Structures between Private Equity and Professional Practices
Private equity funds should consider CPOM prohibitions when investing in professional practices and selecting related transaction structures. Ideally, such transactions should be structured so that a private equity fund cannot exert too much control over a physician’s (or other licensed provider’s) practice, regardless of whether such control is direct or indirect. Otherwise, the private equity fund may be deemed to be engaging in the practice of medicine by interfering with a provider’s independent professional judgment, potentially triggering CPOM violations.
The Friendly Professional Corporation model is a common transaction structure that private equity funds use to acquire professional practices while seeking to avoid violating CPOM restrictions. Under the Friendly PC model, a professional corporation or other permitted professional entity — in which all equity-holders are licensed professionals in the applicable field — employs the physicians and other licensed health care personnel. Generally, the private equity fund selects the equity-holders of the Friendly PC, which owns the clinical assets of the former professional practice and facilitates delivery of medical services to patients. The private equity fund itself forms a management services organization as a separate entity to acquire the nonclinical assets of the professional practice. In exchange for a fee, the MSO then contracts with the Friendly PC to provide it with management services, including billing and collections, employment of non-licensed clinical staff and other administrative functions. Accordingly, the Friendly PC model seeks to separate private equity fund control and ownership from the delivery of medical services by licensed professionals in an effort to avoid violating CPOM restrictions.
Typically, as part of the contractual arrangement between the Friendly PC and MSO, Friendly PC equity-holders relinquish some or all of their economic rights in the Friendly PC in exchange for equity in the MSO, resulting in revenue from the Friendly PC flowing into the MSO, which then distributes profits to its equity-holders, including the private equity fund (and its downstream investors) and the Friendly PC equity-holders (in accordance with their contractual arrangement regarding economic rights).
Private equity funds should also consider CPOM restrictions when setting fees to be paid by the Friendly PC to the MSO for management and administrative services. Many state CPOM restrictions, including in North Carolina, explicitly prohibit fee-splitting where a licensed physician shares revenue on a percentage basis with a non-licensed person. Therefore, fee structures that rely on a percentage-of-revenue structure may carry a higher risk of regulatory scrutiny compared to other fee structures such as flat fees. Fee structures for the management and administrative services component of the Friendly PC model generally should reflect the fair market value of the services provided and be commercially reasonable to provide maximum protection for the arrangement.
Conclusion
As private equity funds continue increasing the pace of their investments in professional practices, transaction structures intended to facilitate compliance with CPOM prohibitions have emerged. Whether the chosen structure is the Friendly PC model or some alternative, the state-to-state variability of CPOM prohibitions, along with increased scrutiny of the private equity acquisition of professional practices, warrants caution – both in compliance with existing CPOM prohibitions and other myriad health care regulatory considerations, as well as potential future regulation in this area.
Sofia Cuadra, a rising third-year law student at the University of North Carolina and summer associate at Robinson Bradshaw, contributed to this post.
