Strategic positioning of physician groups via MSO formation

By Gary Herschman, JD, member, Epstein Becker & Green, P.C., gherschman@ebglaw.com; Conor F. Murphy, JD, senior counsel, Epstein Becker & Green, P.C., cmurphy@ebglaw.com; and John Barry, JD, associate, Epstein Becker & Green, P.C., jdbarry@ebglaw.com

In the healthcare industry, management service organizations (MSOs) — also sometimes known as administrative services organizations (ASOs) and business support services organizations (BSOs) — are entities that provide management, administrative and business support services to a medical practice or other healthcare provider organization.

Recently, medium and large physician groups are forming MSOs to position themselves for greater flexibility to effectively explore various strategic options.

Strategic investor transactions

When physician groups seek investor partners or to become part of a regional or national healthcare organization, it is very common for the physicians to be employed by a professional services entity (owned solely by licensed physicians, also known as a “friendly” or “captive” professional corporation [PC]), and for such practice entity to have an agreement with an investor-owned MSO. The MSO generally provides corporate infrastructure for the practice — such as billing, collections, managed contracting, IT/EHR hardware and software, human resources, non-clinical staffing, compliance, office space, equipment, furnishings and supplies — as well as capital for the development of new offices and ancillary services, for the acquisition of other practices for expansion, and for renovations and new equipment.

Forming MSOs for potential future flexibility

As investor interest in physician groups has grown, some groups have decided to bifurcate their clinical and business/support functions in advance — through the formation of an MSO — so that they are better prepared and positioned for a potential transaction. At the same time, this strategy also enables physician groups to pursue other short-term (and/or long-term) expansion by entering into administrative services agreements, using the MSO’s professional/corporate infrastructure, to provide support services to other, smaller medical practices in the region. 

By leveraging its infrastructure and executive staff, an MSO can achieve and benefit from economies of scale while providing support services to other smaller physician groups in a more professional and cost-efficient manner than such groups are accustomed, creating a win-win for all involved. This also allows physicians in smaller or midsize groups to focus entirely on the clinical care of patients, leaving the business of healthcare in the capable hands of experienced executives and administrative leaders.

Potential legal issues in MSO formation

In connection with forming MSOs, physician groups need to consider and structure their relationships in a manner that complies with various potential legal hurdles, which vary by state, such as:

• Corporate practice of medicine restrictions. Many states prohibit nonphysicians from owning medical practices and from directly employing physicians via regulations, court rulings or some combination of the foregoing, commonly known as the corporate practice of medicine (CPOM) prohibition. At its foundation, this doctrine is focused on restricting nonphysicians from “controlling” medical practices. As a result, relevant state laws need to be carefully reviewed and complied with, such as through making it clear — both in agreements and in practice — that MSOs cannot directly or indirectly exert any control or influence over patient care and clinical services and decision-making. As a practical matter, this makes sense, as most physicians would never take clinical direction from a nonphysician.
• Fee-splitting prohibitions. Some states prohibit physicians and medical groups from splitting the fees earned from the provision of professional services with other persons or entities. Although state laws in this regard differ, in many instances it is improper for physicians to pay for management or administrative services based on a percentage of their collections received for their professional services. In some states, it may be acceptable to pay for such administrative services on a per-service basis, regardless of the amount of collections received. The most conservative way to address this issue in more stringent fee-splitting states is to provide for “fixed” fees under administrative services agreements.  Further, regardless of the fee methodology used, it is advisable for the fee to be supportable as being fair market value in consideration for the administrative services rendered to the medical group (which is a factor that also can better position the arrangement for compliance in states with CPOM restrictions).
• Anti-kickback restrictions. Federal laws governing Medicare, Medicaid and other federal programs, as well as certain state laws, prohibit the payment of any compensation in exchange for (or to induce), directly or indirectly, the referral or recommendation of healthcare services (or influencing the foregoing). Thus, if an MSO performs marketing services for a physician practice, it is crucial for complying with these laws that the fees for the MSO’s services be supported as fair market value, and in connection therewith, percentage-based fees are subject to greater scrutiny.
• Licensure/registration as billing company.  Some states require companies that provide billing and collection services to be registered, certified or licensed as a billing company, and to comply with various regulatory requirements. Because billing and collection services are among the most common services provided by MSOs, it is important when forming an MSO to assess the existence of, and to comply with, any such requirements in all states where the MSO will render services. 

Key steps in forming an MSO

As described above, the formation of an MSO essentially involves the bifurcation of a physician group by transferring its assets and administrative (nonclinical) staff to a newly formed MSO entity (which usually is a limited liability company). The mechanics of transferring nonclinical assets, personnel and operations will depend on the specific services provided by a physician group (e.g., specialty and any ancillary services), as well as the governing laws of the applicable jurisdiction.

Physicians, advanced practice clinicians and other licensed personnel for whom professional services are billed (e.g., physical therapists) remain employed by the physician practice entity, under employment agreements or otherwise. Moreover, staff who perform “designated health services” as defined in the Stark Law — such as radiology technicians, orthotists, lab techs, etc. — may also need to continue to be employed by the practice entity for purposes of regulatory compliance (depending on various factors).

Further, the following other types of agreements need to remain in the name of the medical group entity: managed care contracts; professional services agreements; Medicare/Medicaid participation agreements; accountable care organization (ACO); independent physician association (IPA) and physician hospital organization (PHO) agreements; on-call and coverage agreements; medical director agreements; and any other agreements involving the provision of professional services or which otherwise generate professional service revenue, pharmaceutical supply, and in many states medical waste disposal arrangements. Additionally, it may be required by state law to keep certain clinical equipment with the practice entity.

The following are some common examples of contracts, assets, leases and staff that are transferred to an MSO:

• All nonphysician management personnel (e.g., office manager, CEO, CFO, COO, HR director, IT director)
• All other nonlicensed office staff, such as receptionists, billing personnel, medical assistants, etc.
• Licensed staff whose services are not billed by the practice, such as (depending on the circumstances) RNs and LPNs
• Payroll, benefits programs and HR policies, procedures and handbooks, all of which usually mirror the practice’s existing HR programs
• Office space leases, which likely will require written consent of the landlord (and may be conditioned on an ongoing guaranty from the practice entity, if not other concessions)
• Owned equipment, furnishings and supplies
• Assignment of capital leases and any debt/loans in connection with the purchase of assets (which is also likely to require bank and financing company consent), and assignment of operating leases for equipment and vendor service arrangements.

Tax considerations in structuring MSO formation

The transfer of assets and leases in connection with a physician group’s formation of an MSO can have both income tax and transfer tax ramifications. The tax implications will depend on factors including the type of practice entity involved (e.g., corporation, LLC), the practice’s “tax basis” in its assets and the fair market value of such assets. The practice may simply sell its assets to an MSO in exchange for cash or a promissory note to form the MSO. Also, under certain circumstances it may be possible to structure the transfer of assets to the MSO as a tax-free reorganization or a “spin-off” for federal income tax purposes. Tax counsel and the practice’s accountants should be consulted at the initial stages to evaluate and help minimize the taxes incurred on an MSO formation.