Anesthesia Mergers and Acquisitions and Post-Termination Obligations: Have You Terminated Your Future?
Mark F. Weiss, JD
The Mark F. Weiss Law Firm, Dallas, TX, Los Angeles and Santa Barbara, CA
I pushed the wiring instructions across the table.
A few minutes later, I confirmed that close to $10 million was in the account of my client, the sole shareholder.
Then we all went to lunch.
Ah, the shiny object, the more or less instant gratification. The sale of your anesthesia group and the fresh $1 million in your pocket.
But what comes next? And has your undivided attention on the shiny object created a gap in, or, perhaps worse, a blockade against, your future?
Let’s explore this through the use of a simplified example from the anesthesia mergers and acquisitions world.
Local Anesthesia Medical Group of St. Mark’s County (LAM), not a real group, but a prototype, is owned by 31 physician shareholders. The group agrees to be acquired by a subsidiary of Big Anesthesia Group (BAG), which promises a rosy long-term future for the group’s owners due to BAG’s supposedly higher contract rates and management expertise.
Each of the LAM shareholders receives $875,000. They enter into five-year employment agreements with BAG at $X per year, an amount several hundred thousand dollars per year lower than their average annual compensation prior to the sale. There’s a bonus structure dependent on outsized financial performance.
Each employment agreement contains various termination provisions. Each also includes a valid and enforceable covenant not to compete, effective during the agreement’s five-year term and for the subsequent three years. The covenant prevents any non-BAG work in St. Mark’s County, including any ownership or control of any entity providing anesthesia services.
True Term: Nominal, Minimum and Maximum
You’re probably familiar with the fact that a contract has a “term,” the length of time, commonly expressed in a period of years, during which an agreement is in effect.
For example, a lease might have a one-year term (the time period during which the tenant has the right to occupy the premises), or an independent contractor services agreement might have a two-year term (the time period during which the independent contractor will render services). In the case of the BAG employment agreements in our example, the “term” of each runs for five years.
We’ll call that type of term provision, for reasons that will become crystal clear in a moment, the nominal term. That term of years is “nominal” because a contract’s actual term, the length of time of actively enforceable obligations, often has other, true limits.
A contract’s minimum term is governed by its provisions for early termination. For example, an employment contract with a five-year nominal term and a 90-day without cause termination provision is, in actuality, a rolling 90-day agreement.
Despite the fact that it is entered into on January 1, 2017, with an ending date of December 31, 2021 (a nominal term of four years), the employer could give notice of without cause termination on, for example, February 15, 2017, causing the term to end 90 days later. The date December 31, 2021, was just a placeholder, the end of the nominal term, the outside date on which the term ends. (Or is it? See below.)
At the same time, any contract that contains provisions that survive the earlier termination of the agreement has a maximum term longer than its nominal term. In other words, despite the fact that the nominal term of the contract has ended (e.g., the lease is over and you must move out), certain provisions remain in effect and can be enforced. These are post-termination obligations.
An example of a post-termination provision familiar to most anesthesiologists is one commonly seen in an employment agreement or an independent contractor services agreement that provides for payment on the first day of the same month following the month of service. Drafted properly, even though the contract’s nominal term ends on, say, March 31, payment for services rendered in, for example, the previous February, must still be made in the following April, and so on. The contract still exists and functions as to the obligation of payment (and perhaps much else) even though the nominal term has ended.
M&A&A (Mergers & Acquisitions & Angst)
Let’s return to our example of the sale of LAM’s anesthesia practice to BAG.
Fast forward to year four of the shareholders’ five-year employment agreements, which, as you’ll recall, include a covenant not to compete effective during the agreement’s five-year term and for the subsequent three years. The covenant prohibits any non-BAG work in St. Mark’s County, including any ownership or control of any entity providing anesthesia services.
To date over the four years, bonus payments have not exceeded several thousand dollars per physician. The touted higher reimbursement contract rates never materialized. BAG adopted what can basically be described as a “hands off” management role and the day-to-day tasks and complications of running an anesthesia group have fallen on the former LAM shareholders.
Over the past year, BAG has begun recruiting physicians to the former LAM practice who are willing to work for significantly lower compensation than the $X per year being paid to the former LAM shareholders.
What are the former LAM shareholders to do? What will happen in connection with their potential employment by BAG the year after next, the first year following the expiration of their current five-year employment agreements? And how is their future impacted by the presence of the post-termination obligations, notably the covenant not to compete?
Their compensation was “reduced” (actually, the “excess” amount over $X, what it takes to recruit and retain, was sold) in the sale to BAG. They now hope that their compensation will go up. After all, BAG led them to believe that their better collection rates and better management would lead to increases in their compensation. Yet, as mentioned above, other physicians, the new recruits, are willing to work for significantly less than $X.
Once the sale of LAM to BAG closed and the physician employment agreements with the former LAM shareholders were in place, the former shareholders ceased being entrepreneurs and became employees. They believed that they were trading potential future downside risk for current dollars—to them, a lot of dollars, taxed at preferred long-term capital gains rates, to boot.
The reality was that they traded a swath of risk, what might happen to disrupt their business over the next few years, while retaining what might happen to them, individually, in terms of future opportunities both during their employment by BAG and following it. No longer entrepreneurs, they became what economists call “rent seekers”: They traded their time, efforts and expertise for “rent,” their salary from BAG as their employer.
The fact is, that despite the pitch given on the way in, very few employers of any sort, from large anesthesia groups to personal services entities of any stripe, will overpay “rent.” Overpay is always measured from the employer’s perspective.
If new employees’ services can be “rented” for less, then so be it. This may be shocking to some or even to many, but that doesn’t change the fact that this is how business works.
Of course, in some cases, the employer would be happy to have existing employees remain if they will work for the same “rent” as someone else. (This is a simplification because, with significant time and the formulation and implementation of the right strategy, there are ways to increase the perception of the former shareholder’s value, thus driving higher “rent.” But that’s outside the scope of this article.)
The problem for our former LAM shareholders is that even though their employment agreements will soon end, the covenant not to compete will remain in place. That post-termination obligation is valid and enforceable for the ensuing three years.
The result of that covenant is that the shareholders have lost the option to work in St. Mark’s County following the looming termination of their employment with BAG. That work could have been in the form of working independently, re-starting a local group (even one that doesn’t provide services at any facility previously serviced by LAM), taking a position with (i.e., seeking “rent” from) another group in the county, or even using any of those possibilities as leverage in their negotiation with BAG in connection with their employment beginning in post-sale year six.
The impact of the post-termination obligations of the covenant not to compete, neither seen nor appreciated when negotiating with BAG on the acquisition, is that the LAM shareholders pre-positioned themselves to be sandwiched between what might be a take it or leave it renewal offer (if one comes at all) or having to move out of the county or even out of the state to be able to practice as anesthesiologists independent of BAG.
Nothing I’ve written means that it’s not in any one shareholder’s best interest for their anesthesia group to be acquired.
The important point is that in performing the calculation of the sales price, you must take into account exactly what it is that you are selling and what its value is. All post-termination obligations must be taken into account. An appraiser or even the market itself values the business that is being sold.
But in the sale of an anesthesia group, just as in the sale of any professional services firm, what’s being sold is more than the “business,” more than its cash flow. If a covenant not to compete or other post-termination provisions is included in the deal, it’s also the sale of choice, of optionality, of a slice of your future. What’s that worth to you?
Mark F. Weiss, JD is an attorney who specializes in the business and legal issues affecting physicians and physician groups on a national basis. He served as a clinical assistant professor of anesthesiology at USC Keck School of Medicine and practices with The Mark F. Weiss Law Firm, a firm with offices in Dallas, TX and Los Angeles and Santa Barbara, CA, representing clients across the country. He can be reached at email@example.com.