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Divorcing your practice? Check finances first

A column examining the ins and outs of contract issues

By Steven M. Harris is a partner at McDonald Hopkins in Chicago concentrating on health care law and co-author of Medical Practice Divorce. He writes the "Contract Language" column. Posted March 1, 2010.

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If you are thinking about leaving your practice, or if the practice is splitting apart, ending the relationship and starting a new arrangement is not as simple as walking out the door.

In medical practice divorce, as in marital divorce, all sorts of financial details, large and small, must be settled before the break is legally clean. And some of the decision-making on whether to leave can hinge upon whether you're really getting a better life with your new partners.

This column will examine some of the financial hurdles you will have to consider, including the subjects of banking, leasing arrangements and asset protection, to help determine whether you will be able to get started with what you hope is a new and glorious relationship.

Banking

Among a host of material business issues affecting the medical professional, banking is certainly among the very top. The lack of available financing to expand your practice, whether it is for lessee build-out or recruitment of physicians, has strained, if not shut down, expansion.

Now, with signs of a partial credit thaw, lenders are slowly getting back in the game. In my experience, that is encouraging physicians who stayed in practices despite their unhappiness to decide it's time to go.

When negotiating a financing package for your new arrangement, always remember the "what if" scenarios, especially what if the venture fails or you leave the practice while bank financing remains outstanding.

From most risky to least, understand the difference among the various banking options:

Joint and several liability. Each physician-partner of the practice will personally sign for the entire amount of the credit. If the practice can't pay the debt, the bank can look to any and all of the partners for repayment, although it cannot collect in total more than the debt amount. Let's say build-out plans require $1.5 million and there are five partners in the practice, including you. Joint and several liability will have each partner responsible for the entire amount. If the bank ultimately collects more than $300,000 from any partner, that partner has a right of contribution against any other partner who is subject to the joint and several obligation. This, of course, pits partner against partner (or former partner), which further complicates the divorce or separation should one or more of the partners leave before the loan is paid off.

Several liability. An important variation of the above theme requires each partner to personally guarantee his percentage interest of the loan. Using the example of total debt of $1.5 million, each partner would be responsible for $300,000 and nothing more.

This strategy shifts the risk to the bank to collect each partner's percentage interest in the outstanding debt. It also serves as an important hedge for the partner who is wealthier than his peers.

Several liability with a cap. Same structure as for several liability, but with a limit on personal exposure that is less than the percentage interest in the outstanding debt. Say the outstanding debt is $1.5 million, and several liability for five partners is $300,000 each. Placing a cap at $200,000 will reduce each partner's personal liability by $100,000 if the practice is unable to retire its debt.

In the event the bank requires some form of guaranty from the partners, negotiate the personal obligation to cease after a set period. For example, if the bank note is five years, consider asking the bank to release all personal guaranties after two years so long as there has been no loan payment default by the practice during that time.

However, you might be on the hook for personal guaranties made from your old practice. The fact that you and your partners may have reached agreement in connection with your departure does not mean third parties are bound by that decision.

Accordingly, if you divorce from the practice with debt outstanding, always request a release directly from the bank. Alternatively, if the bank is unwilling to release a departing partner from the debt owed by the practice, negotiate an indemnification from your former partners as part of the exit strategy.

This is not nearly as safe as a direct release from the bank and, importantly, the bank is not bound by the agreement reached by the partners. But if the bank does collect on the outstanding loan from the departing partner, indemnification gives that partner the right to collect from the remaining partners.

Leasing

The strategies described in connection with banking are applicable to lease negotiations.

When negotiating a lease (or a departure from a practice with an outstanding lease obligation), always think of the landlord as a bank. Think of the landlord as lending you space (instead of money) for which the practice and its partners agree to pay rent for a set period. If you master the banking techniques previously discussed, you can apply them to a lease negotiation.

Protecting assets

Protecting your personal assets should be an important part of every physician's game plan, particularly during these kinds of transition periods. As you are aware, practicing under the umbrella of a professional corporation or limited liability company will not shield you from personal liability with regard to a claim of professional negligence.

In essence, the various options of the plans remove title to assets held in the name of the physician. Many of these options allow the physician to remain in control of the asset otherwise transferred from his ownership.

Tread carefully, though, in asset protection planning. If the plan is found to violate tax laws, you're the one who will get in trouble with the Internal Revenue Service.

This is not the final word on medical practice divorce. This column will come back to the issue for one more, often sticky subject: professional liability insurance planning.

Steven M. Harris is a partner at McDonald Hopkins in Chicago concentrating on health care law and co-author of Medical Practice Divorce. He writes the "Contract Language" column.

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