The California Court of Appeals, Second Appellate District (the “Court”) in Epic Medical Management, LLC v. Paquette rendered an decision that was published earlier this year that is helpful to those who engage in provision of management services to physicians or medical groups (possibly other professionals as well) including, without limitation, hospitals, health systems or private equity backed organizations.  In this case, although not directly ruling on the legality of the arrangement, the Court states that if it had so ruled, it would have determined that a comprehensive management services agreement for management of a physician’s practice, which used a percentage-based compensation structure, does not violate California’s anti-kickback statute under Section 650 of the California Business & Professions Code or related fee-splitting or corporate practice of medicine prohibitions.  This decision is most directly relevant to practice, operations and investments in California, but it may also be of use as a point of reference, for context or for its potential persuasive value in other jurisdictions, particularly where corporate practice of medicine prohibitions still remain on the stronger side of the spectrum. 

A physician (“Physician”) and a lay management services company that was at least partially owned by physicians (“Company”) entered into what appears to be a fairly comprehensive management services agreement for the “non-medical aspects of [Physician’s] medical practice” (“Agreement”).  The services to be provided by the Company to the Physician included office space, equipment, non-physician personnel (including nurses), establishment of a marketing plan and marketing services, billing and collection services, accounting services and other support services.  The Agreement provided that the Physician would pay the Company a management fee for all of these services of one hundred twenty percent (120%) of the aggregate costs the Company incurred in providing all of the management services per month, not to exceed fifty percent (50%) of the collected professional revenue plus twenty five percent (25%) of the collected surgical revenues.  However, the compensation arrangement that the parties actually engaged in consisted of the Company charging and the Physician paying a fee of 50% of the revenue for office medical services, 25% of revenue for surgical services and 75% of pharmaceutical-related revenues.  Notably, it later was determined that this formula likely actually provided less profit to the Company than if the parties had stuck to their original compensation terms, as written in the Agreement. 

The parties performed under the Agreement for about 3.5 years until the relationship turned sour and the Physician terminated the Agreement.  The parties entered into arbitration and the arbitrator concluded that the Physician breached by not paying a portion of the management fees that were due (under the compensation structure, as modified by conduct of the parties).  The Physician moved to vacate the determination and award of management fees, arguing in part that the portion of the payments made to the Company under the modified compensation arrangement violated anti-referral prohibitions in California Business & Professions Code Section 650, among other things.  This argument was based in part on a relatively small number of patient referrals made by the Company to the Physician during the term of the Agreement. 

The trial court reviewing the arbitration award denied the Physician’s motion to vacate.  The trial court’s decision was based, in part on rationale that any illegality (if any) resulting from the small number of referrals of patients made by the Company to the Physician under the Agreement and the modified compensation structure was only “technical”, and not material enough to result in a violation.   

At the Second Appellate District level, the Physician argued that California has an absolute public policy against making payments to anyone making referrals, but the Court noted that Business & Professions Code Section 650 (b), expressly permits such payments in circumstances similar to those at issue and reflected in the Agreement.  Based in part on this, the Court concluded that there was no clear or likely contravention of public policy that would render the underlying arbitration award reviewable. 

However, the Court went further and stated that if the arbitration decision and award were reviewable, it would find that the Agreement did not violate the law

The language under Section 650(b) states, in part that “payment or receipt of consideration for services other than referral of patients which is based on a percentage of gross revenue or similar type of contractual arrangement shall not be unlawful if the consideration is commensurate with the value of the services furnished…”.

The Court noted that the only way that the Agreement could have been found illegal is if it had been demonstrated and a finding had been made that the compensation paid to the Company was not commensurate with management services rendered under the Agreement, but there was no such demonstration or finding.  Moreover, the Court also stated that the terms of the Agreement showed a delineation between the medical elements of the practice that the Physician controlled and the non-medical elements that the Physician engaged the Company to handle.  The Court further noted that the Company exercised no control over the Physician’s practice, notwithstanding the modified, percentage-based compensation structure that the parties apparently actually engaged in and comprehensive services provided. 

The Court’s decision provides useful and recent guidance to hospitals, health systems, private equity investors and others who may engage in similar types of management services agreements in connection with their respective growth, alignment and investment strategies.