Federal Bankruptcy Court Stays Envision Healthcare Litigation in California

From the West Coast Healthcare Desk is a new ongoing series of Holland & Knight Healthcare Blog articles and alerts focused on healthcare industry developments and points of interest in the West Coast healthcare marketplace. Holland & Knight's nationally ranked healthcare practice has been focused on healthcare compliance, transactional, reimbursement and operational trends that have often started in California before spreading nationwide – managed care and various capitated and quality-based reimbursement models being the most obvious examples. With the growth of the firm's West Coast-based healthcare team serving regional for-profit and not-for-profit healthcare providers, suppliers and complex integrated payer/provider networks, Holland & Knight is able to provide timely insight into the developments and trends that will impact the healthcare sector both regionally and nationally into the future.

Here is the first article in our series. Stay tuned for more West Coast-focused healthcare news and analysis to come.

Envision Healthcare Corp. and certain of its wholly owned subsidiaries (Envision) recently filed voluntary Chapter 11 petitions in the U.S. Bankruptcy Court for the Southern District of Texas (Bankruptcy Court). In re: Envision Healthcare Corp., Docket No. 4:23-bk-90342 (Bankr. S.D. Tex. May 15, 2023). According to its petition, Envision is a private equity-backed emergency medicine staffing company that provides physician services to at least one-third of U.S. hospital emergency departments, has more than 21,000 employed and partnered clinicians providing care to patients with nearly 30 million visits each year, and has estimated assets and liabilities in the range of $1 billion to $10 billion each year. Not surprisingly, as reported by The Wall Street Journal, the Envision bankruptcy could be one of the largest healthcare-related bankruptcy cases ever.

The Envision Case and the Corporate Practice of Medicine

On the same day that Envision filed for bankruptcy, the American Academy of Emergency Medicine Physician Group (AAEM-PG) vowed to continue its federal lawsuit against Envision – American Academy of Emergency Medicine Physician Group, Inc. v. Envision Healthcare Corporation, et. al., Case No.: 3:22-cv-00421-CRB (Envision Case) – as filed in the U.S. District Court for the Northern District of California on Dec. 20, 2021, claiming, among other things, that Envision is in violation of certain California laws – Cal. Business and Professions Code Sections 2400 and 2052 – designed to protect patients from nonprofessional business corporations practicing medicine. Such laws, which exist in many other states, prohibit what is commonly referred to as the "corporate practice of medicine" (CPOM). As described below, CPOM laws generally prohibit lay entities (e.g., private equity firms) from owning or otherwise controlling professional entities engaged in the practice of medicine.

Notwithstanding AAEMG-PG's resolve to continue its litigation of the Envision Case, on July 13, 2023, the Bankruptcy Court issued an order denying AAEM-PG's motion to lift the stay on the prosecution of the Envision Case – such stay being imposed upon the filing of Envision's bankruptcy petition.

Why Is This Worthy of Attention?

If AAEM-PG prevails in its suit against Envision, one result could be the prohibition of a common business structure used widely by lay entities in California and other states that are subject to CPOM laws that wish to acquire and/or invest in medical group practices while avoiding a violation of the CPOM restrictions. This business structure, commonly referred to as the "Friendly PC Model," has been under attack in California before – most recently in California Senate Bill 642 (SB-642),¹ which was introduced in the State Senate in 2021. However, the Envision Case represents the latest and possibly loudest attempt to undermine the Friendly PC Model. As stated by David Millstein, a lead attorney for AAEM-PG in the Envision Case, in a widely read Kaiser Family Foundation Health News article, AAEM-PG is not "asking [Envision] to pay money, and [AAEMG] will not accept being paid to drop the case." According to Millstein, "AAEM-PC is simply asking the court to ban this practice model."

Why is the Envision case worthy of attention? There is nothing simple about banning the Friendly PC model in California and possibly other CPOM states.

In part fueled by the terseness of Millstein's words, anxiety among the California healthcare investor community has been running high. As a result, the Bankruptcy Court's recent order further delaying the prosecution of the Envision Case has both relieved some and heightened the concern of others.

The Friendly PC Model: A Summary

As noted above, AAEM-PG alleges in the Envision Case that Envision is in violation of California's CPOM laws through Envision's use of the Friendly PC Model. AAEMG-PC specifically alleges that Envision's relationship with Premier Emergency Physicians of California Medical Group P.C. (Premier) violates the CPOM laws and is, in turn, unenforceable and illegal on its face.

As implemented in California and other CPOM states, the Friendly PC Model includes a professional corporation (PC) or other legal entity that is permitted to practice medicine through employed or contracted licensed physicians. In order to provide professional medical services, the PC must be owned exclusively by licensed physicians. As a result, non-physicians – e.g., private equity funds and other unlicensed individuals and entities – cannot have an ownership interest in the PC. As a way to allow lay individuals and entities to fund and participate in the business of a medical practice, the Friendly PC Model involves a lay entity that contracts with the PC through a management services agreement (Management Agreement) to provide management, administrative and other nonclinical services in support of the PC's practice. This lay entity – a management services organization (MSO) – is available for investment and ownership by private equity funds and other nonprofessional entities and individuals. As a result, through the compensation paid by the PC to the MSO pursuant to the terms of the Management Agreement, nonprofessionals can invest and participate in – albeit indirectly – the business of the PC.

In order to keep the PC "friendly" to the MSO and its non-physician investors, the Friendly PC Model includes an arrangement between the MSO and the PC's physician shareholder – i.e., the Friendly Physician² – commonly referred to as a stock transfer restriction agreement or succession agreement (Restriction Agreement). In most iterations, the Restriction Agreement allows the MSO to direct the disposition of the PC's shares by the Friendly Physician. In short, the Restriction Agreement gives the MSO approval authority over the transfer of the PC's shares to a third-party physician. A Restriction Agreement allows the MSO to cause the Friendly Physician to transfer PC shares to an MSO-selected physician in the event that the MSO believes that the interests of the PC and the Friendly Physician are no longer aligned with the interests of the MSO and MSO shareholders.

Finally, in order to comply with the CPOM prohibitions, the MSO and other Friendly PC arrangements commonly include language specifically prohibiting the MSO and MSO shareholders from interfering with or influencing the professional judgment and clinical practice of the PC and the PC's employed and contracted physicians. In this way, although the MSO is responsible for the business operations of the PC, the MSO cannot interfere with the doctor-patient relationship between PC physicians and their patients. Since CPOM laws are specifically designed to protect the doctor-patient relationship and prohibit unlicensed individuals and entities from practicing medicine by influencing a physician's clinical decisions, such non-interference language is designed to protect the parties from violating CPOM laws.

The Facts at Issue

As is often the case, allegations of unfair business practices and CPOM violations arise from contractual disputes or competition between two or more rival businesses. Such is the situation here.

AAEM-PG filed suit against Envision after a community hospital (Hospital) in California awarded a contract to Premier, Envision's Friendly PC, to staff the Hospital’s emergency department. The staffing contract awarded by the Hospital to Premier was previously held by a local emergency medicine physician group (ER Group), a California professional corporation that contracted with the AAEM-PG for management services. After losing its contract with the Hospital, the ER Group determined that it no longer needed AAEM-PG's management services. Therefore, the ER Group terminated its management contract with AAEM-PG. As a result of the damages AAEM-PG would experience due to the termination of the Hospital’s contract with the ER Group and, in turn, the ER Group/AAEM-PG management contract, AAEM-PG filed suit against Envision for unfair business practices, which included Envision's alleged violation of California's CPOM laws as related to Envision's relationship with Premier.

In support of its contention that Envision's relationship with Premier violates California's CPOM laws, AAEM-PG alleges that the Envision/Premier Management Agreement gives Envision the authority to determine, among other things, which and how many Premier physicians to hire, the terms and amount of compensation paid by Premier to Premier physicians, work schedules and other employment terms, including with respect to patient encounters, working conditions and restrictive covenants, the nature of any physician employment-related advertising and the handling of negotiation of provider contracts with third-party payers. These allegations and examples of impermissible control by a lay entity over a PC's medical practice are the common arguments and examples made by Friendly PC Model detractors.

In an Amicus Curiae Brief (CMA Brief) that the California Medical Association (CMA) filed with the District Court in support of AAEM-PG, the CMA wrote, "While a physician may consult with unlicensed persons in making 'business' or 'management' decisions," including, for example, the hiring and firing of physicians, the selection of medical equipment and supplies, setting practice hours, etc., "the physician must retain the ultimate responsibility for, or approval of, those decisions." CMA Brief, pg. 5. In addition, the CMA concluded that the CPOM prohibitions are violated when there is, "a potential that a lay entity would be able to directly or indirectly influence or control physicians." CMA Brief, pg. 7. The CMA identified stock transfer restriction agreements as an example of a type of arrangement that could raise the potential for impermissible influence or control. CMA Brief pgs. 8 and 9.

Industry Comments and Concerns

Given the ubiquity of Friendly PC Model arrangements in California and other CPOM states, there has been no shortage of commentary, both pro and con, by healthcare industry stakeholders.

As with the CMA, the American College of Emergency Physicians (ACEP) filed an Amicus Curiae Brief (ACEP Brief) in the Envision Case. As described by the ACEP to its membership (see ACEP's statement), the ACEP Brief "sides with a physician's right to autonomy in medical decision-making. [The ACEP Brief] was carefully crafted to emphasize the physician-patient relationship as the moral center of emergency medicine and includes several examples of ACEP's strong leadership in this area."

Advocates for physician practice management companies such as Envision, as well as those focused on private equity involvement in the healthcare space, have defended the Friendly PC Model. Such supporters argue that the Friendly PC Model 1) facilitates needed private investments in physician practices that are facing increased cost pressures resulting from increasing healthcare regulatory requirements and low third-party payer payment rates, and 2) allows physicians to focus on practicing medicine without being distracted by administrative matters.

Interestingly, the CMA has some positive and supportive things to say about the Friendly PC Model in its CMA Brief. For example, the CMA writes that the Friendly PC Model can be "desirable" because it, "enable[s] medical corporations to access and take advantage of needed capital and market resources." CMA Brief, pg. 2. According to the CMA, the Friendly PC Model becomes problematic only when it "crosses over into prohibited territory, wherein the lay entity gains undue influence or control over the medical corporation." CMA Brief, pg. 2.

What the Future May Hold

If successful, the Envision Case could prompt legislators, regulators and prosecutors in other states to focus attention on CPOM prohibitions in their own states and take up arms against potential CPOM violations or reinvigorate CPOM prohibitions with new legislation and/or regulation.

Currently, 33 states and the District of Columbia have CPOM laws. In these states and others, the Friendly PC Model and private investment in healthcare more generally are under ever-increasing scrutiny. Nevertheless, even the most enthusiastic supporters of CPOM prohibitions, such as the CMA, admit that appropriately designed integration models that bring together physician practices and private equity investment can comply with CPOM. However, the uneven and often rare enforcement of CPOM laws from state to-state makes it hard to divine which arrangements will stay on the right side of CPOM compliance and which arrangements will trigger regulatory or judicial review. Therefore, it behooves private healthcare industry investors and other stakeholders both to follow the progress of the Envision Case, as well as the reactions and actions emanating from, and taken by, healthcare players in other CPOM states.

Keep your eyes open for future Holland & Knight blogs and alerts for news regarding the Envision Case and its implications.

Benjamin Steinberg is a summer associate in Holland & Knight's New York office.

Notes:

¹ On May 3, 2021, the California Senate Committee on Health approved SB-642, the stated purpose of which was to protect medical decision-making from lay control by prohibiting any lay entity from impinging on a physician group's clinical control by entering into restrictive arrangements with such group – including, specifically, stock transfer restriction agreements – that would give the lay entity control over the group's medical practice assets and business operations. After the Senate Committee on Health approved SB-642, the 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. Although SB 642 remains in the hands of the Appropriations Committee, it could resurface in the future.

² In most cases, the Friendly PC has a single physician shareholder to simplify the Friendly PC structure.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.