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New York’s Highest Court Reaffirms that Insurers May Deny Claims from Professional Corporations that are Improperly Controlled by Non-Physicians

New York’s Court of Appeals recently upheld prior rulings, statutes, and regulations in order to confirm that only licensed physicians may practice medicine in New York. The Court’s ruling in Caruthers v. Progressive Insurance Co. (2019 Slip Op 04643) upheld the finding in the much-cited case of State Farm Mut. Auto. Ins. Co. v. Mallela (4 NY3d 313 [2005]) that an insurer may withhold payment for medical services provided by a professional corporation when there is a “willful and material failure to abide by” licensing and incorporation statutes. The court’s holding in Mallela was based on the premise that because the unlicensed are not bound by the ethical rules that govern the quality of care delivered by a physician to a patient, it would be improper to allow the corporate form to be used as a device to allow nonphysicians to control the practice of medicine. The court’s recent ruling in Caruthers clarified that Mallela does not require a court or jury to find “fraudulent intent or conduct tantamount to fraud” in order for an insurer to withhold payments to a professional corporation improperly controlled by nonphysicians.

TAKEAWAY:  Improperly structuring relationships between medical practice entities (e.g., P.C.s, PLLCs) and businesses owned by non-licensees (e.g., Management Services Organizations (MSOs)), may constitute the unlawful corporate practice of medicine with the result that claims submitted on behalf of the practice to insurance companies can be considered fraudulent. This has major implications throughout the healthcare industry in New York, and, perhaps, other states guided by the reasoning of the court, particularly with respect to private-equity-based arrangements whereby an MSO purchases the assets of a medical practice and enters into a long-term management agreement with the practice.  These types of arrangements should be carefully scrutinized to ensure compliance with the Caruthers/Mallela holdings.

In its decision, the court noted the following problematic business relationships between the physician’s professional corporation and business entities owned by non-licensed individuals: 

  1. The P.C. agreed to lease office premises and medical equipment for a fee comprised of $547,000 per month for the equipment and $30,000 per month for various office premises. The business entity had the right to terminate each lease without cause, regardless of payment, on 30 days’ notice. No similar provision allowed the P.C. to terminate the leases without cause. Indeed, the leases contained clauses whereby they automatically renewed unless terminated by the business entity, thereby giving the P.C. no exit.
  2. The rental fees charged to the P.C. for the medical equipment were “exorbitant. For example, a piece of equipment that the business entity leased from a third party for a monthly payment of $5,950 was leased to the P.C. for $75,000 per month.”
  3. The business entity opened a bank account on behalf of the P.C. The physician owner of the P.C. never wrote a check from the bank account; rather, the businessmen would write all the checks.
  4. The physician’s oversight of the provision of medical services rendered at his P.C. was practically nonexistent and the physician was not involved in evaluating or disciplining employees. There was “absolutely no quality control” or professional supervision at the P.C.
  5. A businessman’s telephone number was listed on the P.C’s tax return (rather than the physician’s phone number). The filed returns contained egregious errors, such as a deduction taken for fictitious management fees in excess of $1,000,000 and the P.C. had “no books and records, such as financial statements, ledgers, and invoices.”

The insurers who brought this action contended that the physician was merely a nominal owner of the P.C.; that it was actually owned and controlled by businessmen who were not physicians; and that the P.C. was not entitled to payment because the physician-shareholder with a medical license did not personally engage in the practice of medicine through such professional entity.

The court agreed and in so doing, noted as follows:

In New York, a professional service corporation may be owned and controlled only by licensed professionals (see Business Corporation Law § 1507). Moreover, licensed professionals are permitted to incorporate only if they are the sole organizers, owners, and operators of the professional corporation (see Business Corporation Law §§ 1503 [a], [b]; 1508) (emphasis added). Once the professional corporation is formed, shareholders may not transfer their voting power to any person who is not a licensed professional in the field (see Business Corporation Law § 1507 [a]); only shareholders or licensed professionals engaged in the practice may be directors and officers (see Business Corporation Law § 1508 [a]).

New York law prohibits unlicensed individuals from organizing a professional service corporation for profit or exercising control over such entities. In the medical context, the underlying policy concern is “that the so-called ‘corporate practice of medicine’ could create ethical conflicts and undermine the quality of care afforded to patients” (State Farm Mut. Auto. Ins. Co. v Mallela, 372 F3d 500, 503 [2d Cir 2004]). More generally, the common law in New York has long recognized the need to ensure that providers of professional services are not unduly influenced by unlicensed third parties who are free of professional responsibility requirements and may disregard patient care in operating a “corporation . . . organized simply to make money” (Matter of Co-operative Law Co., 198 NY 479, 484 [1910]).

If you have any questions about a current or prospective business model involving a medical practice and non-licensees, the arrangement should be carefully reviewed by experienced health law counsel to ensure consistency with the Caruthers and Mallela opinions. Contact Frier Levitt today to speak to an attorney.