For years the goal of many young doctors was to gain ownership in their medical practice entity. For many, when the time came for them to “make partner,” they signed on the dotted line without fully understanding the legal relationships involved and the consequences if things did not work out as planned.
Now we are in an environment of sharply declining reimbursement rates for physician professional services. The “pie” is shrinking every year, and the agreements among co-owners are not as comfortable as they once were.
This article will address common contract provisions that control the process of withdrawing from ownership in a medical practice entity structured as a limited liability company or professional limited liability company (either form will be referred to in this article as an “LLC,” since the differences in these two forms makes no difference to the topics being addressed).
Types of Legal Entities
There are three main kinds of legal entities that contain medical practices: a partnership, a corporation, and an LLC. Speaking very generally, the partnership is a creature of equity, where the partners have a duty to be fair to one another. The corporation is a creature of statute, where legal protections have grown up that prevent the majority shareholders from “oppressing” the minority shareholders. The LLC is a more recent legal form that was created to be a creature of contract and give the parties full power to set their own rules to govern their relationship. LLCs are now authorized by state statutes in all fifty states, and these statutes allow the members of the LLC to create their own deal by contract, for better or for worse.
In other words, if as a member of an LLC you clearly agree that the majority can oppress you, the courts are not going to interfere if they do.
LLC Operating Agreements
The principal contract involved in an LLC is the Operating Agreement. This is the document that states the “deal” between the co-owners, called “members.” It is the Operating Agreement that states how decisions are made in the LLC. Incorporated in many lawyer-drafted Operating Agreements are provisions that allow a majority or super-majority of the members terminate the membership of a member. To add insult to injury, many of these Operating Agreements contain a provision that sets a valuation on the members interest at an artificially low amount, below a fair value, often by having a “certificate of value” adopted by the members by majority vote. Frequently, these “certificate of value” provisions say that the membership is supposed to review and approve new valuations annually, but just as frequently they say that the value expressed on the certificate is valid whether or not the amount is given an annual review.
Certificate of Value
Another common provision of Operating Agreements extends this “certificate of value” concept to voluntary withdrawals. Often, the member who decides to withdraw from membership is paid out at some fraction of the amount stated in the certificate of value, and may or may not get some share of his or her own practice receivables as they are collected after withdrawal.
Imagine that you have spent years building your practice as part of a group, and now either you want to leave or your colleagues have decided they want you to leave. You take your Operating Agreement to a lawyer, and you are told that for all of your hard work and dedication, you get a payout of $2,000 because that is what was on the certificate of value when you and your co-owners last looked at it after you signed the Operating Agreement many years ago.
You say, “But that’s not fair!” Indeed it is not, but in Arizona, no matter how unfair the application of the provisions of your Operating Agreement, if the provision you have accepted is not ambiguous, you have very little chance of getting a court to change the result.
Be Careful When Singing an Operating Agreement
So watch what you agree to! When you get into a contractual arrangement, particularly one that lasts as long and may have so many important consequences for you as an Operating Agreement for your practice entity, get your own lawyer to explain what it means and consider your exit strategy from the arrangement before you commit. With LLCs, there is no fairy godmother law to protect you from the consequences of your own agreement, and the lawyer representing your practice entity in its formation has no duty at all to look out for your potential future interests as a withdrawing member.