Legal Consult: Unfriendly Interpretations of the “Friendly PC Model”

In the decade ending 2021, private equity firms purchased 6,000 physician practices. These transactions typically involve separating the clinical assets from the non-clinical assets of the target practice and having a management services organization (MSO) own the non-clinical assets. The creation or designation of a physician practice, usually a professional corporation (PC) used to hold and operate the clinical assets of the practice, and a management services agreement and other agreements between the PC and the MSO that may include restrictions on successor ownership of the PC. This has been referred to as the “friendly PC model”. The bankruptcy of Steward Health Care has focused new attention on private equity transactions in the healthcare industry. Two recent developments exemplify different approaches that might gain momentum as businesses seek to aggregate or manage professional medical practices and other healthcare providers.

A recent Massachusetts development was the passage in July 2024 of Senate Bill 2881, “An Act Enhancing the Health Care Market Review Process”. This bill seeks to expand the scope of the Commonwealth’s existing Health Policy Commission’s powers to review significant healthcare transactions through the Material Change Notice (MCN) process. That process normally concerns only transactions where the net patient service revenues (NPSR) exceed $25 million. The bill would permit separate transactions to be aggregated to meet this $25 million threshold, meaning that a series of practice acquisitions designed to create a “platform” of practices each below the threshold might in the aggregate trigger the MCN requirement.

The bill also seeks to expand the type of transactions requiring a MCN to include significant for-profit investments in, asset purchases, or acquisitions of direct or indirect control of providers. Currently, an MCN is only required if a provider organization with at least $25 million in annual NPSR proposes to engage in a merger or affiliation with, or acquisition by, an insurer or a hospital or hospital system, or any other such transaction with other providers that increases NPSR by at least $10 million. An entity proposing any significant for-profit investment in a provider organization must disclose extensive information about its prior healthcare practice acquisitions. A private equity firm with a financial interest in a provider organization must post a bond with the Department of Public Health to ensure that its acquired practice complies with significant operational requirements, such as not exceeding a maximum adjusted debt to adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) ratio, not becoming highly leveraged, and not performing stock buybacks.

Finally, the bill also strengthens the existing corporate practice of medicine prohibition by stating that MSOs and corporate employers of healthcare practitioners may not interfere with practitioners’ clinical judgment. The bill requires that the healthcare practice maintain ultimate decision-making authority over clinician employment status, coding or billing decisions, the number of patients seen in a given period of time, and referral decisions. Finally, the bill prevents a person from being a director, officer, or employee of both a healthcare practice and an MSO.

A second development took place in California. A Los Angeles County Superior Court ruled in Art Center Holdings, Inc. et al. v. WCE CA Art, LLC et al. to convey control over a reproductive health practice and its affiliates back to the original physician owners from WCE, a management services organization. The relationship between the physician practices and the MSO used the “friendly PC model” in which a continuity agreement entitled the MSO to select a successor physician owner of the PC in the event of death, loss of license, etc., and a consulting agreement whereby the physician owner would provide nonclinical services to the MSO in return for a separate fee. Termination of the consulting agreement would trigger the MSO’s right under the continuity agreement to require sale of the practice to the MSO’s selected physician.

After the practice sale, the physician owner claimed the MSO underinvested and mismanaged the practice, particularly by undercollecting accounts receivable and causing nonclinical staff to resign. The physician owner filed suit and asked the court to appoint a receiver to transfer control of the practice back to him. This relief was granted by the court.

The court considered whether the MSO engaged in the unlawful practice of medicine. It found that the contractual provision requiring sale of the practice to a physician selected by the MSO constituted “undue control of a medical practice”. This would be the case even if the MSO vested control of the practice in the hands of another California-licensed physician. The court also granted the receivership in part because the continued operation of the practice as controlled by the MSO would be “against public policy and subject the parties to the risk of professional and criminal repercussions.”

The California case is under appeal and does not at this time have precedential significance. Likewise, the state legislative proposals summarized above are not current law. However, the Superior Court’s analysis in At Center Holdings and these state legislative efforts emphasize the role of the corporate practice of medicine doctrine in seeking to limit MSO authority in “friendly PC model” transactions to only non-clinical aspects of a medical practice. This reduced authority would prohibit an MSO from selecting a successor physician owner.

The Massachusetts bill combines both the corporate practice of medicine approach and the expanded use of an existing regulatory process for evaluating significant healthcare transactions. We can anticipate that both approaches will characterize the legal response to private equity-related activities in the healthcare industry.

In light of these legislative activities and litigation outcomes, physicians and other caregivers considering entering into a practice sale with non-professional business entities should pause and consider how best to preserve their professional clinical autonomy in return for ceding control over the business aspects of their practice. Some of the specific restrictions on clinical decision-making described above could form part of a physician practice’s negotiation posture when considering such a sale.

Peter Martin, Esquire is a partner in the Worcester office of Bowditch & Dewey, LLP, his practice concentrating on healthcare and nonprofit law

Physicians Insurance