California Bill to Alter Friendly-PC Model Delayed But Could Resurface in Next Year's Legislative Session

The California Legislature considered a bill (SB-642) this year that would have substantially strengthened the state's ban on the corporate practice of medicine. After the bill passed the state's Senate Committee on Health, the state's Senate Appropriations Committee placed the bill in its "suspense file," which means that the bill is on hold while the Appropriations Committee considers the bill's fiscal impact.

The bill—or an amended version of it—could resurface in next year's 2022-2023 legislative session. SB-642 sought to require a reworking of arrangements between professional medical corporations (PCs) and management services organizations (MSOs).

SB-642 would have added the following section to California's Business and Professions Code:

2408.5. (a) The shareholders, directors, and officers of a medical corporation as set forth in Section 2408 shall manage and have ultimate control over the assets and business operations of the medical corporation and shall not be replaced, removed, or otherwise controlled by any lay entity or individual, including, without limitation, through stock transfer restriction agreements or other contractual agreements and arrangements.

(b) For purposes of this section, "ultimate control" shall mean and be consistent with the definition provided by generally accepted accounting principles.

Current California law prohibits unlicensed individuals or corporations from owning PCs or directly employing physicians pursuant to the theory that corporate involvement in medicine could improperly influence physicians to take into account financial considerations when making clinical decisions. Per the Medical Board of California, the ban on the corporate practice of medicine minimizes "undue influence or interference" with physicians' judgment and the physician-patient relationship.

The proposed section would have called into question the legality of the commonly used "friendly-PC model" in which an MSO—typically owned by unlicensed individuals or entities—provides administrative services to a PC, such as accounting, contract negotiation, real estate management, marketing, human resources, and management of equipment and supplies, among other services. Generally, in this model the PC retains ultimate control over hiring and firing of clinical personnel, choice of modalities and medical services offered, financial issues (including banking), choice of medical equipment, and the content of advertising.

Benefits of the PC-MSO model, which is understood to be permissible under existing California law, can include:

• Allowing the clinical staff of the PC to focus their time and expertise on the delivery of medical services to patients;
• Increasing operational efficiencies by utilizing the MSO's shared resources;
• Increasing access to capital for improvement of the PC's operations and services by serving as a vehicle for investment by non-physician investors; and
• Adding an avenue for physician owners to realize value from the appreciation of the PC.

The PC-MSO model is common in California and other states, including existing PC-MSO arrangements that operate in multiple states.

What Would the Passage of SB-642 Mean for the PC-MSO Model?

The passage of SB-642 would call into question whether existing and future PC-MSO arrangements comply with California law and could lead to medical corporations unwinding or restructuring existing arrangements. The broad scope of the bill could make it difficult to restructure such arrangements.

For example, section 2408.5 of the proposed bill would require that shareholders, directors, and officers of a PC "manage and have ultimate control over the assets and business operations of the medical corporation." Because this language is so broad, it is unclear whether this requirement would wholly prohibit a PC from hiring a MSO to manage the administrative business operations of the PC.

Additionally, Section 2408.5 would prohibit an MSO from entering into stock transfer restriction agreements or other contractual agreements or arrangements that would permit the MSO to replace a shareholder of a PC. This prohibition could make it difficult for PCs to obtain financing from investors through their arrangement with an MSO, as stock transfer restriction and similar agreements are essential to achieve financial and tax consolidation and otherwise support investment by non-physicians through the MSO. Such arrangements are particularly common among medical clinics, group practices, and ambulatory surgery centers.

Davis Wright Tremaine is continuing to monitor SB-642 and other similar legislative activity.