Unfortunately many physicians have elected to conduct their practice as a Professional Association (P.A.) without any consideration for the asset protection consequences of this arrangement. This problem occurs because attorneys and accountants are misinformed about the options available to the physician in the choice of legal entity. Many of these advisors believe that a physician can only create an entity under the Professional Service Corporation and Limited Liability Company Act of Florida (the PSCLLC Act), either as a P.A., P.L. or a PLLC. Unlike other professionals (for example, dentists), there is no statutory requirement that physicians be the sole owners of a medical practice. The PSCLLC Act is a permissive statute that allows licensed professionals to organize as a P.A. or PLLC. The statute specifically was adopted in 1961 because in the 1950's the IRS had questioned the validity of professionals who were incorporated under the general corporation acts from establishing corporate retirement plans (a position the IRS abandoned more than 20 years ago when the Tax Equity and Fiscal Responsibility Act of 1982 substantially eliminated the discrepancy between self-employed and corporate retirement plans). Most significantly, the Florida Secretary of State has allowed the creation of professional practices under the Florida Business Corporation Act (Inc.) and under the Florida Limited Liability Company Act (LLC).
Further, some professional medical services have historically been rendered through entities with non-physician owners, for example, non-physician owned private hospitals and medical clinics. The problem of the tremendous growth and inadequate supervision of non-physician controlled medical clinics led the Florida legislature to adopt the Health Care Clinic Act of 2003. Under this law, the owners of medical clinics have to go through extremely burdensome and thorough licensing approval (much more extensive than a physician faces initially being licensed to practice medicine). However, certain non-licensed physicians are exempt from the Health Care Clinic Act (equity owners who are the spouse, parent, sibling or child of the physician) and thus do not have to register as a health care clinic. The Board of Medicine has also allowed trusts and other entities controlled by these same close relatives to be exempt from registration.
While the physician’s professional advisors are frequently unaware of the choice of entities available to their clients, they are almost all oblivious to the asset protection risks of conducting a practice as a P.A. This problem really arose after the Florida Supreme Court held in 1967 that a creditor of a professional who solely owned his P.A. (an attorney in this case) had the same post-judgment remedies that are available to a creditor of a shareholder of a general corporation (Street v Sugerman, 202 So.2d 749, Fla. 1967). Thus, once a judgment creditor of a professional obtains their judgment they can foreclose against the stock interest in the P.A. When they foreclose their security interest, the creditor actually becomes the shareholder of the entity, gains total control of the company and they can then hire and fire personnel, including the physician.
Some advisors argue that a creditor can not become a shareholder of a P.A. because the PSCLLC Act limits the equity ownership of a P.A. to a person who is licensed in the same profession in which the entity operates. This is true if the entity wanted to continue in business as a P.A. But, in Florida Statute §621.10 it provides that if a member becomes disqualified to be a shareholder and there is no buy-out of their interest, then the entity can be judicially dissolved or administratively dissolved by the Secretary of State. For the sole practitioner, this means that the entity is dissolved and the creditor can close down the practice (including firing the physician).
Some sole practitioners respond to this problem by suggesting that they will simply reopen their practice using a new entity. However, such a new practice would still be responsible for the debts of the prior entity and will likely be a fraudulent transfer (see Amjad Munim, M.D., P.A. v. Azar, 648 So.2d 145, Fla.App. 4 Dist.,1994 in which the court held that the new entity was liable to the old entity’s creditor on four different legal theories).
For the physician in a group practice a different set of problems arise. Again, in the absence of a buy-out of their interest, the creditor can force the dissolution of the practice (and based on the Munim Case holding prevent the debtor physician from creating a new entity in substantially the same geographic area with the same patients). Thus, it is crucial that the group practice has a formal business continuation agreement in place that requires the buy-out of the debtor physician’s equity interest. In the absence of a prior buy-out agreement, the creditor could cause the P.A. serious legal pain (for example, dispute in valuation, required cash liquidation of interest, etc.). More importantly for the debtor physician who owned the interest in the P.A., their creditor receives a cash-out of the equity interest and the debtor loses a valuable asset.
The solution to the above problems is to establish the practice as a multiple member limited liability company. Statutorily, a creditor of a member of an LLC does not become a member of the LLC [Fla. Stat. §608.433(4)], they can only receive a charging order (similar to a writ of garnishment). If distributions are made, the creditor receives a portion of the distribution (equal to the percentage of membership interest owned by the debtor physician). If no distributions are made the IRS still requires the assignee of the LLC membership interest (the creditor) to report the income earned in the entity on their tax return. Many creditors are not pleased to find out that they have to pay income taxes on phantom income and are anxious to sell out their interest when they receive the first K-1 or Form 1099 from the LLC.
Because of a bankruptcy court case from Colorado (In re Ashley Albright, 2003 Bankr. Lexis 291, April 4, 2003) this limitation on a charging order is not guaranteed when the entity is a single member LLC. Thus, to avoid the results in the Albright case there should always be two members of the LLC (for married physicians, the spouse might hold a 10% membership interest with the physician holding a 90% interest; for the single physician a gift giving trust would likely hold the 10% interest). For the married physician even greater protection can be offered by use of tenancy by the entireties ownership in the LLC (creating two layers of protection).
In conclusion, in asset protection planning the physician typically protects individual assets but fails to protect the most important asset in their life–their continued livelihood. When a judgment creditor receives their judgment (the cake) there is no reason to give them access to your livelihood (the icing on the cake).
To learn more on protecting your practice of medicine, you may want to acquire our seminar entitled “Protecting the Medical Practice” available on DVD, audioCD and videotape (please call 561-967-2772 for further information).
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