Associate Agreements: Negotiating Hidden Pitfalls and Benefits

Michael Kowalski, DDS, JD

Michael Kowalski, DDS, JD, has lectured and authored numerous peer-reviewed professional journal articles and textbook chapters on risk management, professional liability and dental licensing issues. Dr. Kowalski has defended doctors for over 20 years in the areas of professional liability, administrative licensing board actions, business law and estate planning. Conflict of Interest Disclosure: None reported.

ABSTRACT: Some of the significant factors to consider with an associate agreement are whether the associate dentist will be classified as an independent contractor or employee, provisions to protect the trade secrets of the practice and a workable method of dispute resolution.

We all deal with contracts in our lives. Dentists are no different. However, the business of dentistry is changing. In particular, due to the significantly higher cost of a dental education, fewer new dental school graduates are buying existing dental practices. More dental school graduates are looking for jobs as associates in existing practices because they cannot afford to purchase an established practice. Moreover, there has been a recent fluctuation in California law concerning independent contractors. This article provides an overview of associate agreements, with the spotlight on classifying an associate as either an independent contractor or an employee.

Written contracts provide structure and stability to a dental practice. Errors or poor judgment in contractual relationships can seriously harm a practice. Dentists emphasize prevention to their patients. Prevention in the form of knowledge and guidance from legal professionals allows dentists a way to avoid some of the common pitfalls of working with contracts and can make a smooth and profitable associateship.

Essential Elements

One of the first contracts a new dental school graduate or specialist will enter into upon completion of a residency is an agreement to be an associate dentist for an owner-dentist of an established practice. The associate arrangement is a contract. Like any other contract, it can be oral or in writing. Basically, a contract is a set of mutual promises that the law will enforce. The elements of any contract include terms that were bargained for by both parties. There is a meeting of the minds where each party understands what they must give up to get what they want from the agreement, which results in an agreement where the parties have realistic expectations.

Two prime issues come up with associate agreements. The first is whether the associate dentist should be treated as an employee or an independent contractor. The second has to do with protecting the practice from competition by the associate after separating from the practice.

In California law, the default is generally that an associate is an at-will employee, unless altered otherwise by an agreement between the parties. At-will employment is defined in the California Labor Code as employment having no specific term and that it may be terminated at the will of either party without notice to the other party.[1]

However, under the California Unemployment Insurance Code, the definition of employment does not include professional services performed by a consultant working as an independent contractor. In fact, there is a rebuttable presumption that a dentist is an independent contractor when providing professional services.[2]

Independent Contractors

The California Labor Code defines an independent contractor as “any person who renders service for a specified recompense for a specified result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished.”[3]

Practice owners often find it attractive to have their associate dentist classified as an independent contractor because the owner will pay less in withholding taxes, will not have to provide benefits, including a 401k profit sharing plan, will not need workers’ compensation insurance and will be insulated from liability for any negligent or intentional acts of the associate dentist.

In April 2018, the holding in a California Supreme Court case, Dynamex Operations v. Superior Court (Dynamex),[4] appeared to make it impossible to classify an associate dentist as an independent contractor. The court established an “ABC” test. To avoid being considered an employee, a worker must A) be free of the hirer’s control; B) do work that is “outside the usual course of the hiring entity’s business;” and C) be established in a trade similar to the work being performed. A worker must satisfy all three criteria. It is the second prong that precludes associate dentists working in a dental practice from being classified as independent contractors. Moreover, in Vazquez v. Jan-Pro Franchising International Inc., the 9th Circuit, in May 2019, concluded that Dynamex applies retroactively.[5] The decision confirmed that employers were exposed to liability for failing to comply with the ABC test, which employers claimed they had no reason to believe that they had to comply with because it had not previously existed under California law.

Exemption for Dentists

The California Legislature sought to codify Dynamex with California Assembly Bill 5 (AB 5). However, included in AB 5 is an express exemption for dentists (among others). The bill’s exemption for dentists provides:

“Subdivision (a) and the holding in Dynamex Operations West Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903 (Dynamex), do not apply to the following occupations as defined in the paragraphs below, and instead, the determination of employee or independent contractor status for individuals in those occupations shall be governed by Borello. (1) A person or organization who is licensed by the Department of Insurance pursuant to Chapter 5 (commencing with Section 1621), Chapter 6 (commencing with Section 1760), or Chapter 8 (commencing with Section 1831) of Part 2 of Division 1 of the Insurance Code. (2) A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California pursuant to Division 2 (commencing with Section 500) of the Business and Professions Code, performing professional or medical services provided to or by a health care entity, including an entity organized as a sole proprietorship, partnership, or professional corporation as defined in Section 13401 of the Corporations Code.” (Emphasis added.)

Gov. Gavin Newsom signed AB 5 in September 2019, and it took effect Jan. 1, 2020. It should be noted that the exemption applies to dentists and not to registered dental hygienists nor to registered dental assistants.

Now with the passage of AB 5, Dynamex and its ABC test are inapplicable to licensed dentists in California. Thus, what we are left with is the common law test as to whether an associate dentist can be classified as an employee or independent contractor.

To establish an associate’s status as an independent contractor, it was never enough to simply label the associate an independent contractor even in a written contract.[6]

The most important common law factor in determining whether an employment or independent contractor relationship exists is the right of control in determining the method and means of accomplishing the desired results.[7] What has been known as the control test looks at how much right the employer has to direct and control the manner and means by which the job is performed. Factors to consider include whether the owner provides instruction and supervision, how and when the work is done, materials used, who furnishes the instruments, equipment and supplies, billing, authority to hire and fire staff and who owns the patient records.

In California law, the default is generally that an associate is an at-will employee, unless altered otherwise by an agreement between the parties.

Although the issue of determining whether an associate has employee or independent contractor status is a fact-specific determination, there is no one dispositive checklist to make the determination. For years, the IRS has used a 20-factor test (TABLE), often termed the “right-of-control” test, to determine if an employee can truly be classified as an independent contractor. Under the IRS rules, an independent contractor controls the manner and means by which contracted services, products or results are achieved. The more control a business exercises over the how, when, where and by whom the work is performed, the more likely the worker will be found to be an employee and not an independent contractor. Associate dentists are not a good fit with the IRS factors. In fact, it is estimated that as many as 80% to 90% of independent contractors in California are misclassified. Such misclassification can have serious consequences for the owner of a dental practice, as it may result in government audits by the Employment Development Department (EDD) and other agencies where penalties and back taxes might be assessed.

Although a worker does not have to meet all 20 factors to qualify as an independent contractor and no single factor is determinative, the key issues in determining independent contractor status is who controls the means and manner of work. Other important factors include who provides equipment and instruments, if the worker is integrated into the employer’s business, if taxes are withheld, if benefits are paid and the degree of control of assistants.

It is instructive to look at the 20 factors and see how independent contractor classification of an associate in the private dental practice setting is problematic (SEE TABLE).

For a dental practice owner who prefers to have their associate dentists classified as independent contractors, being aware of these 20 factors is essential. The dental practice owner must attempt to structure an independent contractor agreement that is more likely to be upheld under IRS scrutiny by taking into careful consideration these 20 factors.

The IRS usually classifies workers as employees whenever their status is not clearcut. Moreover, the IRS has traditionally maintained that a written independent contractor agreement between the parties is not sufficient evidence to determine independent contractor status, especially if facts indicate otherwise. For tax collection purposes, the IRS has a strong incentive to find that a worker is an employee.

Under the IRS rules, an independent contractor controls the manner and means by which contracted services, products or results are achieved.

Employers, including dental practice owners, who are uncertain about how to classify a worker can request an IRS determination by filing Form SS-88, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Requesting a work status determination means the owner of a business is asking the IRS to establish if the services the associate provides to the business are those of an employee or independent contractor.

Tips for Independent Contractor Status

Currently, the first factor analyzed during an EDD audit is whether the associate dentist is incorporated, because a professional corporation cannot be an employee. Therefore, owner-dentists should have their associate dentists form a professional corporation. The practice owner then enters into an independent contractor agreement with the professional corporation with the professional services being provided by the associate as an employee of their professional corporation.

Even without the new Dynamex ABC test, an associate dentist often does not fit well into the IRS determination factors; in addition, there is a real concern that classifying the associate as an independent contractor could possibly be considered fee splitting, which is in violation of the California Dental Practice Act.8 The danger of running afoul of the fee splitting prohibition is that a percentage fee agreement means the owner will share fees with the independent contractor. The owner is referring patients to the independent contractor and receiving a fee.

Ostensible Agency

Additionally, classifying an associate dentist as an independent contractor may not provide the protection from liability as hoped for by the practice owner. To obtain as much protection as possible for the acts of the associate dentist, the practice owner will have to, at a minimum, inform in writing all patients treated by the associate of the associate’s independent contractor status. Otherwise, the practice owner could still be held liable for the actions of the independent contractor under the theory of ostensible agency. The theory states that there is an implied or presumptive agency where the owner either intentionally or from want of ordinary care induces another to believe that a third person is the owner’s agent.

Moreover, if the dentist owns two or more dental practices, classifying associates as independent contractors provides no protection from liability, even with an indemnification provision[9] in the associate agreement, as the owner has strict statutory liability for all dental services rendered in each office owned pursuant to the California Dental Practice Act.[10] In fact, when a dentist owns more than one practice, the dentist must apply to the Dental Board of California for an Additional Office Permit and declare, under the penalty of perjury, in the application that the dentist is accepting legal responsibility and liability for dental services rendered in each office maintained by the dentist.[11] The public policy behind this statutory strict liability is to ensure the owner-dentist maintains reasonably close and direct supervision of professionals, employees and operations.

Classifying an associate dentist as an independent contractor has some potential pitfalls. It may be more prudent to classify the associate as an employee to avoid possible violations and penalties.

Anti-Competition

Another common concern for practice owners is protecting their practices from competition when an associate separates and moves on to open their own practice or work for another office. Often, a covenant not to compete is incorporated in the associate agreement. The practice owner may believe that as long as the covenant is reasonable as to length of time and geographic distance of the prohibitions, that it is enforceable. Unfortunately, California law is unambiguously clear that a covenant not to compete is illegal and unenforceable. California Business and Professions Code section 16600 states, “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” The policy consideration behind the statute is the promotion of open competition, which has been the rule in California since at least 1872.[12]

The law does provide an exception when the goodwill of the business, which has been defined as the expectation of continued public patronage, is sold.[13] Therefore, a covenant not to compete that is reasonable as to time duration (three to five years) and geographic distance (depending on whether the practice is in an urban or rural community) in a dental practice purchase contract is enforceable because the purchase price includes an allocation for the intangible but valuable property of the goodwill. In the associate agreement where there is no compensation for goodwill, any restrictive covenant is therefore void.

The alternative to a nonenforceable covenant not to compete, to give the practice owner some protection, is incorporating trade secret provisions into the associate agreement. A trade secret is defined under the Uniform Trade Secret Act[14] as “information, including a formula, pattern, compilation, program, device, method, technique or process that … derives independent economic value actual or potential, from not being generally known to the public or other persons who can obtain economic value from its disclosure or use.”[15] A trade secret does not have to be copyrighted, patented or even novel to be kept as trade secrets by the user. As long as they are kept secret by the user by limiting access and right thereto and are obtained improperly, then a tort, for which there is a legal remedy, has been committed. Trade secret law, however, does not protect against discovery by fair and honest means such as independent invention, accidental disclosure or reverse engineering (starting with the known product and working backward to figure out the process that aided in its development or manufacture).[16]

Another common concern for practice owners is protecting their practices from competition when an associate separates and moves on.

Protected information, such as patient records, computer data, patient ledgers, promotional material, patient lists, appointment calendars and holiday/ Christmas or promotional lists, are protected as trade secrets of the practice. A former associate, however, would still be able to make a general announcement of their new practice without it being a violation of trade secret law. Also, patients seeking out the former associate cannot be prohibited from doing so.

Alternative Dispute Resolution

In the vast majority of contracts between owner and associate dentists, the result is a smooth working relationship or transition. In the associate agreements we have analyzed in this article, a new graduate, for example, obtains their first job practicing dentistry while an established practitioner grows their practice. The initial professional relationship may lead to a practice buy-in and/or partnership. However, dentists, like all people, may have disputes with each other. While we may hope people can work out their own differences, sometimes they simply cannot. Then they must either turn to the court system or some form of alternative dispute resolution (ADR) to assist them in reaching a resolution.

ADR became popular 30 or so years ago as a way to unclog a jammed court system where it was not uncommon to take five years for a case to go to trial. ADR has proved to be an effective way to resolve disputes and, thus, provisions for ADR should be incorporated in associate agreements. However, ADR is not without its drawbacks and so ADR clauses must be carefully scrutinized.

The two forms of ADR that are typically placed in contracts between owner and associate dentists are mediation and binding arbitration. The first form of ADR in mediation is a private informal dispute resolution process. A neutral third party, the mediator, helps the parties reach a mutually acceptable agreement. No formal evidence is presented at the mediation, the mediator does not hear sworn testimony, does not make evidentiary rulings and has no power to impose a decision upon the parties. The process is confidential and is not admissible as evidence in a later proceeding, such as a civil action or arbitration.[17]

Mediation is particularly well suited when the parties have an ongoing relationship such as an associateship or partnership. For example, many landlords are becoming more sophisticated and incorporating mediation provisions in their dental office leases. In contrast, when a dispute is venued in civil court or arbitration, it results in a winner and a loser versus a compromise. It is often difficult to continue a civil relationship after going through such an adversarial process. The aftermath could result in the dissolution of an otherwise profitable associateship or partnership. Usually the costs of mediation, which are mostly the mediator’s fees, are equally split between the parties. If mediation fails to resolve the dispute, a more formal means of dispute resolution will be required.

The second form of ADR, binding arbitration, has been offered as one option to the civil court system. Some of the advantages of binding arbitration include lower court expenses, reduced expense and time of the parties, speedy settlements that lessen the disruption of the parties’ lives, enforceability, privacy, choice of applicable norms and accessible forums for people with disputes.[18]

A binding arbitration clause inserted in a contract provides for compulsory binding arbitration to resolve disputes as to rights or liabilities under the contract. The skill of the attorney drafting the arbitration provisions is a critical factor in whether the arbitration will be an effective and efficient dispute resolution method or an expensive and time-consuming quagmire. The arbitration clause will state what rules of arbitration will apply, such as the rules of the American Arbitration Association (AAA) or the California Arbitration Act.[19]

Provisions in the arbitration clause for selection of an arbitrator and the number of arbitrators are key factors in how smoothly and how cost-effective the arbitration will be for the parties. The arbitrator is typically a retired judge or a retired or practicing attorney. Unlike the judge in civil court, whose salary is paid by the county, the arbitrator’s fees are paid by the parties and are typically $400 to $500 per hour or more. Some arbitration clauses call for a panel of three arbitrators to hear the matter, costing at least $1,200 to $1,500 per hour, which would make the arbitrators’ fees alone cost prohibitive for most disputes. Because the parties contemplating arbitration are already in a dispute, it would not be surprising that they will not be able to agree upon an arbitrator to hear their dispute. Thus, a well-drafted arbitration clause will have a provision for such a contingency. Often, the default provision will be to defer to the chief administrator of an arbitration service such as AAA or JAMS-ENDISPUTE to select the arbitrator. If no provision is made for selection of the arbitrator, the parties will have to engage in the costly endeavor of filing a petition with the superior court and have a judge appoint the arbitrator.

Another factor that will greatly influence the costs and, perhaps, the outcome of arbitration is whether or not there is a provision in the arbitration clause to allow for discovery (fact gathering) by the parties to do such things as take depositions and subpoena records. Discovery will significantly increase the costs of arbitration. However, the cost must be balanced against the fact that without adequate discovery, a party may not have sufficient evidence to put on an effective case.

Some of the advantages of binding arbitration include lower court expenses, reduced expense and time of the parties and speedy settlements.

One clear advantage of arbitration is the expediency of the arbitration process, and the resulting decrease in stress, that might alone make arbitration worthwhile for busy dentists. A jury trial could easily last one or two weeks whereas an arbitration might be completed in one or two days. Again, expediency of the process depends on the skill of the attorney who drafted the arbitration clause.

Disadvantages include the common complaint that arbitrators tend to find a compromise, a sort of “splitting the baby,” just for settlement sake rather than producing a decision on the merits. Following arbitration, there are exceedingly limited grounds for appealing the arbitrator’s decision. Finally, the parties waive their rights to a jury trial by engaging in binding arbitration.

Conclusion

Some of the significant factors to consider with an associate agreement are whether the associate dentist will be classified as an independent contractor or employee, provisions to protect the trade secrets of the practice and a workable method of dispute resolution.

Personal relationships are governed by a complex, and typically unwritten, set of social rules and norms. Some behaviors are encouraged, others required and some forbidden.

The same is true in dental business relationships. Usually the difference, whether the business relationship is short term or long term, is that it should be governed by a written contract. A written contract provides structure and efficiency to the business relationship. It removes the risk of differences in recollection. The initial cost in time and effort in drafting the associate dentist agreement is outweighed by the reduction of negotiations and disputes during the term of the agreement.

REFERENCES

1. Labor Code § 2922.

2. Unemp Ins Code § 656, which states in pertinent part: “ … there shall be a rebuttable presumption that services provided by an individual engaged in work requiring specialized knowledge and skills attained through completion of recognized courses of instruction or experience are rendered as an independent contractor. These services shall be limited to those provided by attorneys, physicians, dentists, engineers, architects, accountants, chiropractors … .”

3. Labor Code § 3353.

4. Dynamex Operations v. Superior Court, (2018) 4 Cal.5th 903.

5. Vazquez v. Jan-Pro Franchising International Inc., No. 17-16096 (9th Cir. 2019).

6. Kowalski v. Shell Oil Co. (1979) 23 Cal.3d 168,176.

7. Empire Star Mines Co. v. California Employment Comm. (1949) 28 Cal. 2d 33; S. G. Borello & Sons Inc. v. Department of Industrial Relations, (1989) 48 Cal.3d 341.

8. Business & Professions Code § 650 makes it unlawful for one licensed in the healing arts to receive or accept “any rebate, refund, commission, preference, patronage dividend, discount, or other consideration, whether in the form of money or otherwise,” as compensation or inducement for the referral of patients. The statute was intended to prevent “the referring person [from being tempted] to suggest or prescribe extra, or more expensive services by the person to whom the patient is referred because the referring person’s income is a function of the business he generates by referral.” (53 Ops.Cal.Atty.Gen. 117, 118 (1970.) The evil to be proscribed by section 650 “is not just the payment for the referral, but also any relationship where the referral may be induced by considerations other than the best interests of the patient. ” (63 Ops.Cal.Atty.Gen. 89, 92 (1980); fn. omitted.) “Certainly a sick patient deserves to be free of any reasonable suspicion that his doctor’s judgment is influenced by a profit motive.” (Magan Medical Clinic v. Cal. State Bd. of Medical Examiners (1967) 249 Cal.App.2d 124, 132, 57 Cal.Rptr. 256.)

9. An indemnity agreement is a contract that “holds a business or company harmless” for any burden, loss or damage. An indemnity agreement also ensures proper compensation is available for such loss or damage.

10. Business & Professions Code § 1658.1, which states: Nothing in this chapter shall be construed to prohibit a licensed dentist from maintaining more than one dental office in this state if all of the following conditions are met: (a) In addition to any existing legal responsibility or liability, a dentist maintaining more than one office shall assume legal responsibility and liability for the dental services rendered in each of the offices maintained by the dentist. (b) A dentist maintaining more than one office shall ensure that each office is in compliance with the supervision requirements of this chapter. (c) A dentist maintaining more than one office shall post, in an area which is likely to be seen by all patients who use the facility, a sign with the dentist’s name, mailing address, telephone number, and dental license number.

11. Title 16 CCR 1045-1048; 1057.

12. Edwards v. Arthur Andersen LLP (2008) 44 Cal. 4th 937, 945.

13. Business & Professions Code § 16601; Hill Medical Corporation v. Russell R. Wycoff (2001) 86 Cal. App. 4th 895, 902.

14. Civil Code §§ 3426 et seq. Uniform Trade Secrets Act.

15. Civil Code § 3426.1(d)(1).

16. Witkin 13 Equity, § 81. 17. Evidence Code §§ 1115 et seq.

18. Paths to Justice: Major Public Policy Issues of Dispute Resolution, National Institute for Dispute Resolution, Appendix I Table 4.

19. Civil Procedure Code §§ 1285 et seq.

THE AUTHOR, Michael Kowalski, DDS, JD, can be reached at MKowalski@professionals-law.com.