For better or worse, medical practices are experiencing change. While many physicians are looking to expand their practice, other physicians are seeking a divorce from their current group.
No matter which option you are personally considering, banking should be a top business consideration when weighing your transition options. The lack of available financing, whether it is for an office build-out, recruitment of physicians or the purchase of medical equipment, has strained, if not shut down, expansion. Now, with signs of a partial credit thaw appearing, lenders are slowly getting back in the game.
When negotiating a financing package, always remember the “what if” scenarios: What if the venture fails? What if the practice is unable to make its payments? What if I leave the practice while bank financing remains outstanding? You will need to understand the following banking options as they apply to the personal liability of the owner of a medical practice.
Personal guaranty. Even though the line of credit or term loan is taken out on behalf of the practice, the bank will likely require the physician-partners (and sometimes the spouses of the physician-partners) to personally guaranty the practice’s debt. You may not think twice about signing a personal guaranty for your practice; after all, you believe wholeheartedly that your practice will prosper. When you sign a personal guaranty, however, you are essentially acting as a cosigner. If the practice fails to make its payments, the bank will look to you for payment. Sometimes banks require that the partners secure the practice’s debt with personal collateral, like the physicians’ homes.
Burn off personal guaranty after a period of time. In the event the bank requires some form of personal guaranty from the physician partners, you may be able to negotiate for a cease of personal obligation after a period of time. For example, if the loan is for five years, consider asking the bank to release all personal guaranties after a period of two years, so long as there has been no default by the practice with regard to repayment of the loan during that time.
Sometimes banks require that the physician partners secure the practice’s debt with personal collateral, like the physicians’ homes.Joint and several liability. Banks typically require each physician partner of the practice to personally sign for the entire amount of the credit (whether line of credit or term loan). While the bank can collect only the full amount of the debt, it can look to any and all of the partners for repayment if the practice is otherwise unable to repay it. Let’s say, for example, that the build-out plan requires $1.5 million and there are five partners in the practice, including you. Joint and several liability will have each partner responsible for the entire $1.5 million. If the bank collects more than $300,000 from any one partner, that partner has a right of contribution against any other partner who is subject to the joint and several liability obligation. In other words, if the bank collected $400,000 from partner number one, that partner has the right to collect $100,000 from the other partners. Of course, this pits partner against partner (or former partner), which further complicates the relationship if any of the partners leaves before the loan is paid off. This option also substantially disfavors the partner who enjoys the largest personal net worth vis-à-vis his or her colleagues.
Several liability. An important variation of the above theme requires each partner to personally guarantee his or her percentage interest of the loan. Using the example of total debt of $1.5 million, each partner would be responsible for $300,000 and nothing more, which means the bank could collect a maximum of $300,000 from each partner. This essentially shifts the risk to the bank to collect each partner’s percentage interest in the outstanding debt. It also serves as an important hedge for the physician-partner who is wealthier than his colleagues.
Several liability with a cap. This concept incorporates the same structure as above, but with a limit on each partner’s personal exposure, which is less than the percentage interest in the outstanding debt. For example, say the outstanding debt is $1.5 million and several liability for five partners is $300,000 each. If the bank will permit a cap to be placed at $200,000 for each partner, each partner’s personal liability is effectively reduced by $100,000 in the event the practice is unable to pay off its debt.
Guaranties after you leave the practice. If you are leaving your practice, you need to be aware of any and all practice liabilities for which you may be personally responsible, like a guaranty on the practice’s debt. The fact that you and your partners may have reached agreement in connection with your departure does not mean that third parties—like a bank or landlord—are bound by that decision. Accordingly, if you leave the practice with debt outstanding, the best option is to request a release directly from the bank. If, however, the bank is unwilling to release a departing partner from the debt owed by the practice (and why should it?), you should negotiate an indemnification from your former partners as part of your exit strategy. An indemnification arrangement among the parties typically provides that the practice and the remaining partners agree to assume the departing physician’s financial responsibility. While this internal indemnification is not nearly as safe as a direct release from the bank, and, importantly, does not bind the bank to the indemnification agreement reached by the partners, it does provide the departing partner some peace of mind and the right to collect from the remaining partners if necessary.
Before you and your partners sign on the dotted line, consider (and negotiate) these banking options. The last thing you want is to be on the hook for a “what if” scenario that you thought would never arise. ENTtoday
Steven M. Harris, Esq., is a nationally recognized health care attorney and a member of the law firm McDonald Hopkins, LLC. He may be reached at sharris@mcdonaldhopkins.com.
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