FAQs about Ownership of Medical Corporations

Who in California can own a medical corporation?

As specified in the California Business and Professional Code, the following people may be the shareholders, officers, directors, or professional employees of a medical corporation:

• Licensed doctors of podiatric medicine;
• Licensed psychologists;
• Registered nurses;
• Licensed optometrists;
• Licensed marriage and family therapists;
• Licensed clinical social workers;
• Licensed physician assistants;
• Licensed chiropractors;
• Licensed acupuncturists;
• Naturopathic doctors.

The California Medical Board and California Codes state that an unlicensed person cannot own any shares of a medical corporation. At least 51% of the shares must be owned by a licensed physician and surgeon. The remaining 49% can be owned by the individuals specified above.

What is a Medical Practice?

Since no corporation but a Medical or Professional Corporation can run a medical practice, it is important to understand the definition and scope of that under the law.  According to the California Business and Professional Code, section 2051, the practice of medicine is defined as the:

“use of drugs or devices in or upon human beings and to sever or penetrate the tissues of human beings and to use any and all methods in the treatment of diseases, injuries, deformities, and other physical and mental conditions.”

This is further supplemented by the various sections of the Business and Professions Code, and other California Laws, which delineate the scope of practice for each of the licensees listed above.

Are there any Federal Restrictions?  What is the Stark Law?

What is often called the Stark law is comprised of three separate provisions that regulate physician self-referral to Medicare and Medicaid patients because of the possible conflict of interest. This often limits physicians’ ownership of health care companies, because they cannot refer from their own medical practice.

For example, Physicians may not refer patients to any medical facilities in which they have financial interest including ownership, investment, and a structured compensation arrangement. A physician’s self-referral could possibly encourage over-utilization of services which would increase health care costs. Self-referral could also cause a captive referral system which would limit competition from other providers.

Physicians are also banned from referring patients to immediate family members who include spouses, parents, grandparents, children, grandchildren, brothers, sisters, mothers-in-law, fathers-in-law, brothers-in-law, sisters-in-law, daughters-in-law, sons-in-law, and also adopted and step members of their families. Referring to an immediate family member would also be another conflict of interest. There is no stated regulation in the Stark law against referring to more distant relatives. The physician referring to the distant relative however, still may not have any financial interest or gain from the referral.

What is the History of the Stark Law?

• Stark I- Congress included provisions in the Omnibus Budget Act of 1989 (OBRA 1989) which barred self-referrals for clinical laboratory services under the Medicare program effective January 1, 1992. This provision also included a series of exceptions to the ban in order to accommodate legitimate business arrangements.
• Stark II- (OBRA 1993) expanded restriction to a range of additional health services and applied it to Medicare and Medicaid. This provision also contained some clarifications and modifications to the original law. The Social Security Amendments of 1994 also contained minor technical corrections to these provisions.
• Phase III- The final rule was published on September 5, 2007 and it became effective December 4, 2007. This contains two major changes which are the repeal of the prohibitions based on compensation arrangements and the reduction in the list of services subject to the ban.

Need for an Exit Strategy When Starting a Business

When business people are starting a new company together they are most often thinking about its future and their potential profits. Those initial investors and managers are, at that point, happy to be working together and see the true potential that they can provide their customers, as well as the potential gains for themselves. Unfortunately, however, many are short-sighted when it comes to considering the possible difficulties that can arise in any business relationship.

Problems can arise in a business for many different reasons. These include arguments over distribution of profits, how best to serve clients, which product is best for the market, what roles within the corporation individuals should play, and an infinite amount of other problems. If the initial investors have not carefully thought out how to deal with these problems prior to them arising, then they are required to negotiate in a situation where they are already upset with each other and unlikely to be able to reach a settlement happy to any, let alone all.

In order to prevent this situation, initial investors should begin by carefully setting out an agreement, which deals with potential problematic situations prior to them arising. This agreement could be part of the shareholders agreement in a corporation, the operating agreement in a limited liability corporation, or the partnership agreement in any form of partnership. This agreement should include different provisions, including what roles within the company all are going to play, i.e. who will be president, treasurer, secretary. The corporation should also decide at the shareholder and director levels who will enforce these rights and who will be a tie-breaker if a mutual cannot be reached.

Perhaps the most important element of these types of agreements is what is often known as a “Buy-Sell Agreement”. A Buy-Sell Agreement sets forth the terms and conditions under which any one of the initial investors can sell their investment. This prevents the original founders from being forced to work with people whom they did not originally foresee. It also allows for the setting of a fair price for ownership interest, should the group no longer be able to work together.

The setting of a new price is especially important when there will be a number of small investors and one large or majority investor. If a dispute arises, oftentimes that majority shareholder or majority owner will be able to control the business, to the great detriment of the minority shareholders. If this situation continues and the investors are unable to reach an agreement, the minority investors may have to bring a lawsuit for involuntary judicial dissolution of the business. This is often a disastrous consequence for all involved because it is very difficult for any one to get a fair price for a business when it is being split up and the sale mandated by a court.

In order to prevent this situation, the Buy-Sell Agreement should set forth the price under which the partnership interest, limited liability corporation member units or shares will be purchased in the event of a shareholder leaving. The simplest form is to set up what is known as a Right of First Refusal, where the corporation or other shareholders have the right to purchase the ownership interest at a price negotiated with a third party. However, this presents problems for the selling shareholder, since many are not willing to bid full price for a business when they know that another party can swoop in through exercising a Right of First Refusal.

Other ways to set value can be based on book value, i.e. the value of the assets owned by the business. Companies and investors might also elect to value based upon revenue or profits. Another popular choice is to retain an independent appraiser with expertise in that specific field of business to set a fair value for the business interest being sold. None of these situations is right in all circumstances; instead, they depend greatly upon the specifics of the business in question. For this reason, it is important to consult with a corporate attorney licensed in your jurisdiction whenever engaging in any investment opportunity.