Why a Physician Needs A Shareholders Agreement
By: Sandra P. Greenblatt, Esq. and Joel Schuessler, Esq.
It might be best to start this article with a short story based on real life. Imagine that you have decided that it is time to start your own medical practice. It just happens that at the same time, you see your colleague, Dr. Smith, at a medical society meeting. Dr. Smith is in the same practice specialty and you have often consulted with Dr. Smith on difficult patient cases. The two of you get along well. Dr. Smith is also thinking about opening his own practice, so you propose that the two of you open a practice together. After speaking with your accountants, you and Dr. Smith decide that structuring your new practice as a professional corporation, or “PA”, is the way to go. In the interest of saving costs, and since filing the documents with the Florida Department of State to form your professional corporation seems to be a relatively simple task, you decide not to seek the advice of your lawyers. You and Dr. Smith do not enter into a shareholders’ agreement for the new PA [or, if you have selected a limited liability company, “LLC,” you and Dr. Smith do not enter into an Operating Agreement for the new practice – this article applies equally to any entity].
You and Dr. Smith find office space, take a bank loan to finance your new practice, sign a lease, hire some administrative staff and get down to the hard work of growing a medical practice together. After a year or two of hard work, the new practice is beginning to become successful. Then Dr. Smith begins to change. He’s often late to come into the office and some days doesn’t even show up. One morning you show up to your office, and there’s a letter from Dr. Smith waiting for you. The letter tells you that he is getting a divorce, he’s decided that he simply won’t be practicing with you anymore and wishes you the best of luck. In a panic, you call your lawyer and ask her what you should do you’ve signed a long term lease on office space that is too large for a single physician practice to support, you personally guaranteed the repayment of the bank loan that financed the build out of the new office space and you no longer have a second physician to help support the financial obligations of the practice! The first question your lawyer asks you is, “let me see your shareholders agreement.” You respond that you don’t have one. Unfortunately, your lawyer tells you, there’s not a lot she can do for you to force Dr. Smith to honor his financial and other obligations relating to the practice. InFlorida, you can’t force Dr. Smith to sell or return his shares in the PA to you. You (and the bank or landlord) may be able to force him to honor any personal guaranty he entered into, but that requires the PA to default on its obligations, which you don’t want to have happen. And, if Dr. Smith decides that he would rather file for bankruptcy, there’s not much you can do. As they say, you can’t squeeze blood from a turnip.
Maybe Dr. Smith decides that he wants to sell his shares to another physician, one with whom you simply don’t get along, or worse, to a non-physician, which will invalidate your PA under Florida law! Again, without a shareholders’ agreement, you won’t be able to prevent him from doing so. Or maybe, since Florida no longer prohibits the corporate practice of medicine for osteopathic and allopathic physicians, you and Dr. Smith had decided originally to structure your practice as a regular business corporation (“Inc.”), rather than a PA. [Note: As of July 1, 2008, chiropractic physicians may not be employees or independent contractors of a corporation or other business entity owned by anyone other than chiropractic physicians and their immediate relatives, with limited exceptions.] Dr. Smith later dies, passing his shares in the business corporation on to his wife, who is not a physician. Now, you will be faced with having Dr. Smith’s widow as a shareholder in your medical practice, entitled to the benefits of ownership while not contributing to the bottom line. Should Dr. Smith instead pass his shares to someone other than his spouse or immediate family member, under Florida law, you also will be forced to get a clinic license and be regulated by AHCA to lawfully continue operating your practice! Or, maybe it will be you who decides to pursue another opportunity. We can imagine a multitude of other scenarios, but the point is, shareholders’ agreements allow physicians to plan in advance how the PA (or Inc) will deal with common events like retirement, divorce, disability, death, or just moving on, which can have a significant impact on the operation and life of their practice and the shareholders.
Shareholders’ agreements for physician practices commonly address the following issues:
- Shareholder Qualifications – Do you want to place restrictions on who is permitted to be an owner (shareholder) of the corporation? For example, only licensed medical doctors who are employed by the practice, or only doctors who are approved unanimously by the shareholders.
- Management of the corporation –
- Do the shareholders want to guarantee that certain shareholders will be named to the Board of Directors?
- Do the shareholders want to define a specific method for resolving management deadlocks?
- Transfer restrictions – Should the corporation and/or the shareholders have the option to purchase a selling shareholder’s shares before that shareholder is permitted to sell his or her shares to a third party?
- Buy Outs –
- Will a shareholder be required to sell his or her shares back to the corporation (or the remaining shareholders) in the event that the shareholder dies, gets divorced, or becomes disabled?
- Will a shareholder be required to sell his or her shares back to the corporation if the shareholder or the corporation terminates the shareholder’s employment?
- How will the corporation finance any required buy-out of a shareholder, pay expenses and recruit a replacement doctor?
- How will shares be valued in any of the situations where a shareholder is required to sell his or her shares back to the corporation: an outside appraisal, a pre-set formula, negotiation, or some other method?
- Non-competition provisions – Do the corporation and remaining shareholders want to prevent a departing shareholder from opening a medical practice nearby or soliciting their patients?
- Pre-emptive rights – Do you want to grant shareholders rights so that in case the corporation ever issues additional stock, the existing shareholders will have the right to purchase additional shares to maintain their respective ownership percentages.
In summary, the valuable purpose of a shareholders’ agreement [or operating agreement of an LLC] is to provide, in advance of any crisis or major event, a blueprint for the practice and all of its shareholders, to follow, so you will be able to handle common business events and more complicated situations in the way you have designated. Without such document, you and your fellow shareholders are left by default with only the rights and remedies provided by Florida statutes, which may not provide you with the protection or outcome you desire. When a major event impacts your practice, such as Dr. Smith’s divorce in our hypothetical, the relatively small investment in a well drafted and thought out shareholders’ agreement, you made at formation, or as early as possible in the life of your practice, will far outweigh the stress and cost of the protracted litigation and/or negotiations needed to unravel the situation you will face without it.
Sandra P. Greenblatt is a Board Certified Health Lawyer and President of the health law firm of Sandra Greenblatt, PA, in Miami, FL. Joel Schuessler, Esq. is a former Associate of the firm. The firm may be reached at 305-577-9995, or [email protected] Ms. Greenblatt represents physicians and other health care providers and businesses in their transactional, regulatory and contractual matters. This article is an overview of the subject matter and is not intended and does not constitute legal advice, which must be tailored to a particular party and factual situation after individual consultation.