Administrative Eyecare
Essential elements of all practice agreements

“While all agreements and business entities are different, certain essential elements that clarify expectations for how those entities will operate should be contained in each of your practice agreements.”

All too often, ophthalmology practices forget to review their existing agreements to determine if they are still appropriate and properly working for them. Instead, practices usually wait until a problem emerges to find out that their various agreements do not work well, do not work well together, or do not address the issues they now face. While all agreements and business entities are different, certain essential elements that clarify expectations for how those entities will operate should be contained in each of the practice agreements. Practice administrators should periodically review the practice’s existing agreements and be sure to make the practice owners aware of any problem or discrepancies.
Although the list that follows is by no means exhaustive, consider that each agreement should adequately cover the following principles.
Valuation

The main valuation agreement for each entity that involves or is related to your practice (e.g., Shareholders’ Agreement, Partnership Agreement, Operating Agreement, etc.) should provide some mechanism for how it is to be valued, the appropriate date of the valuation, and the payment terms of a potential buy-out. Shareholders’ Agreements, for example, should state the value of the stock and any conditions on that valuation, and so on. (Even an Employment Agreement [the contract between an employee and an employer] for a practice’s owners often contains deferred compensation or severance pay language that includes a valuation approach.) Whether the entity under consideration is the practice itself, an ancillary entity (such as an ambulatory surgery center), or a real estate entity, the valuation terms should be clear and consistent with the fair market value method for the applicable entity and with your expectations for payment—because if the agreement is silent, then it is anybody’s guess, and this can be a problem if there is a discrepancy in the value. For example, if steady revenue is being generated, will you use the most common valuation methodology for that entity or will you deviate if it results in a higher (or lower) value? What is the fair market value of the entity? Do you have a “formula” to determine the value? (When the entity’s owners are at odds with each other is hardly the time to make this determination.)
Compensation or return on i nvestment?

You should know how you are paid for your ownership and/or other involvement in the entity, particularly because different entities pay differently and, in some entities, it may be beneficial to have more than one payment method. For example, your interest in an ancillary entity (such as an ambulatory surgery center) may be passive and you may not play an active role in its management, so you may receive income distributions only. On the other hand, the entity’s manager may be paid separately for management activities. How will that management payment be structured? The same is also true for the practice entity. What is the compensation plan in the practice? Is it fair? Do you follow it? Who implements it? This may seem obvious, but each agreement for each entity that pays a compensation or return on investment amount should clearly define the payment parameters and who controls them.
It is not just a matter of whether you are to receive compensation or a return on your investment. You should also know when that payment is calculated and paid, the differences in the tax treatment of the payments, and if the payments are mandatory or permissive. For example, if you are paid a salary from your practice, how often will you receive your bonus? Is it mandatory that you receive it by year end or only permissive at the practice’s election? What about the ancillary entities? For so-called “pass-through entities” (S-corporations, LLCs, and partnerships), because you will be taxed on your share of the entity’s profit even if you do not receive a distribution, is there a provision requiring a specific amount of distributions to be made each year (e.g., distributions at least equal to taxes incurred)?
Admission / withdrawal / expulsion of members

How do you get to be an equity owner in the entity, and once you are one, what could make you cease to be an owner? Can you withdraw? Under what conditions? How much notice must you give or would you receive? Can you hang on to your interest even if you are no longer active in the entity or the related practice entity? For example, if you are a member of an ambulatory surgery center but you cease to take call coverage or to operate, can you maintain your ownership interest? What if you retire from your practice? How long after your retirement (if at all) will your interest be redeemed? Again, for each entity in which you have a stake, you should be able to answer this ownership question. Thus, whether it is your Employment Agreement, Shareholders’ Agreement, Real Estate Partnership, Ancillary Venture LLC Operating Agreement, etc., how are new members admitted and how does this affect you? Could you be redeemed against your will? What other ramifications would result if that did occur? Is this what you intend?
Governance and control

Who actually manages the entity day-to-day and at what cost? Are there decisions that are delegated to some status holders and not to others? For example, in a practice professional corporation, it would not be uncommon for the shareholders to have the ultimate authority on some matters (such as admitting or expelling equity holders), the Board of Directors to manage on a lower level (hiring or terminating new associate ophthalmologists), and a managing doctor/partner and/or practice administrator/manager to manage on a day-to-day basis (hiring or terminating staff members).
Again, each entity may be managed differently and each agreement should be clear as to who controls it. For example, for purposes of an Employment Agreement, decisions on firing an employee are usually made by the Board of Directors—but if only the shareholders can fire an equity-holding employee, does that change the control or governance issue?
Automatic provisions

The use of automatic provisions forces the entity to take action upon the occurrence of some event. These provisions are used when the concern is that the entity may not act, or where its failure to act immediately may cause other repercussions (such as loss of professional corporation status). A common automatic provision is that an ophthalmologist’s employment will terminate immediately if the ophthalmologist loses his or her medical license (this is common in an ophthalmologist’s [including an owner’s] Employment Agreement). You should know if there are any other such automatic provisions and if they work together across the agreements or the related entities. For example, are ophthalmologists whose employment terminates also subject to redemption under the ancillary venture agreements? Are there other automatic provisions that you should have in your agreements?
Questions to ask

In our experience, where practice and related entity agreements have not been reviewed in a number of years, they do not dovetail very well. Often this may be simply because they were drafted by different attorneys at different times to meet different needs. Now is as good a time as any to take out your essential practice and related entity agreements and ask yourself a few important questions, such as those in the previous sections of this article, as well as the following:
Do the agreements work together?

Is the valuation mechanism or formula of each entity consistent with the way similar entities are valued these days and in this market? Will the present valuation approach reach the value intended if one of the owners was bought out today? Is it consistent with the fair market value for this entity? Does it matter? Is the compensation model for each entity consistent with your intentions? Is it clear and are you following it? If not, what changes are needed to adapt it to what you are actually doing? How do you authorize those changes? How do you expel equity holders with whom you do not want to work or who are not holding their own? Is this right? Is it too high a standard? Too low? Who controls the entity fundamentally, and is this right? Do you use the authority of your Board of Directors and/or your shareholders in the way your Bylaws suggest? Do you have a managing doctor/partner and is it a properly authorized position? Do you know the scope of his or her authority? Is it a compensated position? What actions are automatic in your agreements and can they be reversed? If a stated event occurs, what other repercussions might/should happen in response?
Advice

Obviously, you should fully understand all of your practice and related entity agreements and their important elements. Each one serves a different purpose. However, you should be able to clarify in your own mind that each of your agreements at least contains the essential elements discussed above.

Mark E. Kropiewnicki, JD, LLM (610-828-3888; mkrop@healthcaregroup.com), is a principal consultant with The Health Care Group, Inc., and a principal attorney with Health Care Law Associates, P.C., both based in Plymouth Meeting, Pa.