Forming A Practice Group Part 3: Planning For The Unexpected
In an ideal world, partners in a medical or dental practice would work until they are ready to retire, then sell their interest in the practice to their other partners or to a new doctor in a seamless transition. Unfortunately, we do not live in an ideal world. Although it can be a difficult topic to discuss, one of the most important issues to consider when forming a practice is to plan what to do if you or one of your partners suddenly dies or becomes unable to continue practicing.
If you do not plan ahead, and one of your partners unexpectedly becomes unable to practice, you could face considerable disruption and uncertainty in your practice. Even more important, you or your family could lose your investment in the practice if you die or become disabled. Although the havoc caused by a sudden death or disability cannot be entirely avoided, it can be minimized by careful planning and drafting of the practice’s formation documents.
Potential Consequences
In order to understand the importance of planning ahead for death or disability, it is important to understand the consequences if you do not plan for the unexpected.
Legally, the default rule under Arizona law is that the death of a general partner or member in a limited liability company constitutes an event of withdrawal.[1] If the formation documents do not account for a partner’s death, under some circumstances the death can trigger a possible unintended dissolution of the practice entity under Arizona law.[2] This can expose the practice to liability and create unnecessary costs to re-form the practice with the surviving partners.
If you form a professional limited liability company, the consequences can be more drastic. Not only is a partner’s death considered an event of withdrawal under the default rules governing limited liability companies, but Arizona requires that each of the members or shareholders of a professional limited liability company or professional corporation be licensed in the same profession.[3] Therefore, in the event a member of the practice becomes disabled and can no longer practice, the disabled partner may be forced to withdraw as well.
In the case of withdrawal, under either a limited partnership or limited liability company, the withdrawn member and his heirs do not have any right to receive distributions from the practice and cannot participate in the ongoing management of the practice. At best, the member or his heirs may have some claim to receive some return on the interest at some indefinite point in the future.
Practically, the effect of sudden death or disability can be daunting, particularly if the practice has only a few doctors. For example, if the practice only has three doctors, and one must stop working right away, a third of the production may be lost overnight, requiring the remaining doctors to dramatically increase their own workload or bring on a locum tenens doctor to fill the gap, at significant extra cost.
Tips To Minimize Disruption
The legal disruption of an unexpected death or disability can largely be avoided through carefully drafting the practice agreement to take into account unforeseen contingencies. For example, the agreement could provide that in the event of death or disability of any of the doctors, that doctor’s interest in the practice will automatically be repurchased by the practice at either a set amount or based on the fair market value of the interest at the time of death or disability.
Additionally, the practice members should carefully consider how to define terms like disability. Although death is an obvious triggering event, many times, disability is a temporary event, with the doctor being able to return to work in a matter of weeks or months. Therefore, you should consider whether to include a time element, such as a disability that continues for more than three or six months, or a substantive element, such as a disability that renders the doctor totally and permanently unable to resume practicing in your particular area, into the practice agreement.
Financially, the practice can protect itself by purchasing insurance to cover any losses. For example, business overhead policies can provide coverage for the increased cost of bringing in a new doctor to share the workload at the practice during either a temporary or permanent disability. “Key man” life insurance policies or disability buyout policies, in which the practice is named as the beneficiary in the event of death or disability, can provide the funds necessary to repurchase a deceased or disabled member’s interest in the practice.
Depending on the circumstances, there may be obstacles to collecting under these policies, particularly with disability policies. However, they remain the best safeguard against unforeseen financial loss. In any event, the best way to protect your practice is to plan ahead and work with experienced attorneys to establish the framework for a successful practice.
[1] See A.R.S. §§ 29-323(6); 29-733.
[2] See A.R.S. § 29-344.
[3] See A.R.S. § 29-844.